Washington, D.C. 20549
Indicate by check mark whether Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer,” “large accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
As of, October 31, 2008 the number of shares outstanding of each of the issuer’s classes of common stock was as follows:
NEOPHARM, INC.
NEOPHARM, INC.
(unaudited)
The financial information herein is unaudited. The balance sheet as of December 31, 2007 is derived from audited financial statements.
The accompanying unaudited condensed consolidated financial statements of NeoPharm, Inc. and subsidiary (“we”, “us”, “our”, or the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, these financial statements do not contain all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated interim financial statements contain all adjustments (consisting of normal recurring adjustments) necessary to a fair presentation. The results of operations for the three and nine month period ended and as of September 30, 2008 are not necessarily indicative of our operating results for fiscal 2008 or future interim periods.
The unaudited condensed consolidated financial statements include the accounts of NeoPharm, Inc. and its wholly owned subsidiary, NeoPharm EU Limited. As of and through September 30, 2008, the subsidiary had nominal assets and had not conducted any business. All significant intercompany accounts and transactions are eliminated in consolidation.
While we believe that the disclosures presented herein are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the financial statements and notes included in the Company’s 2007 Annual Report on Form 10-K filed with the United States Securities and Exchange Commission, or SEC.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense during the reporting periods. Actual results could differ from those estimates.
Amounts presented have been rounded to the nearest thousand.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. In February of 2008, the FASB issued FASB Staff position 157-2 which delays the effective date of SFAS 157 for non-financial assets and liabilities which are not measured at fair value on a recurring basis (at least annually) until fiscal years beginning after November 15, 2008. The Company adopted SFAS No. 157 on January 1, 2008, but the adoption did not have a material impact on its consolidated financial statements. See note 5 below.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008, but the adoption did not have a material impact on its consolidated financial statements.
Reclassifications
Certain reclassifications have been made to conform prior period consolidated financial statements and notes to current period presentation.
The following table sets forth the computation of basic and diluted net loss per share:
| | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, 2008 | | | September 30, 2007 | | | September 30, 2008 | | | September 30, 2007 | |
| Numerator: | | | | | | | | | | | | |
| Net loss | | $ | (2,411,000 | ) | | $ | (881,000 | ) | | $ | (5,996,000 | ) | | $ | (9,949,000 | ) |
| Denominator: | | | | | | | | | | | | | | | | |
| Weighted average shares outstanding | | | 28,492,954 | | | | 28,377,120 | | | | 28,490,910 | | | | 28,189,815 | |
| | | | | | | | | | | | | | | | | |
| Loss per share - basic and diluted | | $ | (0.08 | ) | | $ | (0.03 | ) | | $ | (0.21 | ) | | $ | (0.35 | ) |
As we have incurred net losses in each of the periods presented, basic and diluted loss per share amounts are the same. Common share equivalents of 1,629,325 and 1,339,387 at September 30, 2008 and 2007, respectively, have been excluded from the computation since the effect of their assumed conversion would be anti-dilutive.
3. | SHARE-BASED COMPENSATION |
We currently sponsor the following share-based payment plans:
2006 Plan
In June 2006, our stockholders approved the NeoPharm, Inc. 2006 Equity Incentive Plan, or the 2006 Plan. The 2006 Plan originally provided for the issuance of stock options, non-vested stock, restricted stock, performance units or performance share awards to employees, directors and consultants convertible to up to 1,000,000 shares of our common stock. During the second quarter of 2007, the Board of Directors approved resolutions increasing the total shares available for issuance under the 2006 Plan to 3,400,000 shares and increasing the number of shares of Common Stock that may be granted to any Grantee during any calendar year, or earned by any Grantee under any performance based award during any calendar year, from 500,000 to 750,000 shares. Each of these Board resolutions were approved by the shareholders at the Annual Meeting of Stockholders held in August 2007. In 2008, the Board approved an increase in the number of shares of the Company’s common stock that may be awarded under the 2006 Plan as restricted stock or bonus stock from 500,000 to 1,500,000 and this Board resolution was approved by the shareholders at the Annual Meeting of Stockholders held in August 2008. Awards under the 2006 Plan generally consist of stock options having an exercise price equal to the average of the lowest and highest reported sale prices of our common stock on the date of grant; vest ratably over four years; have a 10 year term; and are subject to continuous employment. Stock awards granted to our non-employee directors under the 2006 Plan typically vest one year from the date of grant. Awards under the 2006 Plan vest immediately upon a change in control, as defined in the 2006 Plan. Although the 2006 Plan provides for the issuance of performance units and performance shares, we have not made grants of these types of awards. As of September 30, 2008 and December 31, 2007, 1,981,139 and 2,260,139 shares, respectively, were available for issuance under the 2006 Plan.
2006 Employee Stock Purchase Plan
In June 2006, our shareholders approved the 2006 Employee Stock Purchase Plan, or the Purchase Plan, under which eligible employees may purchase shares of common stock quarterly through payroll deductions. An aggregate of 100,000 shares of common stock may be issued under the Purchase Plan. The price per share under the Purchase Plan is 85% of the lower of the closing price of the common stock on (i) the first business day of the plan period or (ii) the purchase date. The Purchase Plan imposes a limitation upon a participant’s right to acquire common stock if immediately after or prior to purchase, the employee owns 5% or more of the total combined voting power or value of our common stock. During the three and nine month periods ending September 30, 2008, 4,140 and 8,499 shares, respectively, were issued under the Purchase plan resulting in compensation expense of $775 and $2,790, respectively. During the three and nine month periods ending September 30, 2007, 978 and 12,734 shares, respectively, were issued under the Purchase plan, respectively. As of September 30, 2008 and December 31, 2007, 37,896 and 46,395 shares remained available for issuance, respectively.
The 1998 Plan
Our 1998 Equity Incentive Plan, or the 1998 Plan, provided for the grant of awards, primarily stock options, to employees, directors, and consultants to acquire up to 4,600,000 shares of our common stock. Following the June 2006 shareholder approval of the 2006 Plan, no further awards have been or will be made under the 1998 Plan. Option awards under the 1998 Plan were generally granted with an exercise price equal to the closing price of our common stock on the date of grant, but may have been granted with an exercise price of not less than 85% of the fair market value of our common stock. Option awards under the 1998 Plan typically had a 10-year life and vested ratably on the first four anniversaries of the grant, subject to continuous employment. Stock awards granted to our non-employee directors under the 1998 Plan typically vest one year from the date of grant. Outstanding awards issued under the 1998 Plan vested immediately upon a change in control, as defined in the 1998 Plan.
Amounts recognized in the consolidated statements of operations with respect to our share-based compensation plans were as follows:
| | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, 2008 | | | September 30, 2007 | | | September 30, 2008 | | | September 30, 2007 | |
| | | | | | | | | | | | | |
| Research and development | | $ | 40,000 | | | $ | 34,000 | | | $ | 120,000 | | | $ | (7,000 | ) |
| Selling, general and administrative | | | 86,000 | | | | 79,000 | | | | 288,000 | | | | 235,000 | |
| Total cost of share-based payment plans during period | | $ | 126,000 | | | $ | 113,000 | | | $ | 408,000 | | | $ | 228,000 | |
We have never capitalized, or recognized an income tax benefit from, share-based compensation.
The following is a summary of activity relating to option awards to employees and non-employee directors during the nine months ended September 30, 2008:
| | | Number of Options | | | Weighted Average Exercise Price/ Grant Date Fair Value | | | Weighted Average Remaining Contractual Life in years | | | Aggregate Instrinsic Value | |
| Outstanding at December 31, 2007 | | | 1,252,326 | | | $ | 5.79/4.20 | | | | | | | |
| Granted | | | 279,000 | | | $ | 0.42/0.29 | | | | | | | |
| Exercised | | | - | | | | | | | | | | | |
| Forfeited/expired/cancelled | | | (37,500 | ) | | $ | 3.72/2.34 | | | | | | | |
| Outstanding at September 30, 2008 | | | 1,493,826 | | | | 4.84/3.52 | | | | 8.76 | | | $ | - | |
| | | | | | | | | | | | | | | | | |
| Exercisable at September 30, 2008 | | | 657,901 | | | $ | 4.30/2.94 | | | | 7.82 | | | $ | - | |
| | | | | | | | | | | | | | | | | |
| Weighted-average fair value of options granted during the period | | | - | | | $ | - | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Nonvested at December 31, 2007 | | | 755,051 | | | $ | 1.92/1.37 | | | | | | | | | |
| Granted | | | 279,000 | | | | 0.42/0.31 | | | | | | | | | |
| Vested | | | (170,626 | ) | | | 1.96/1.41 | | | | | | | | | |
| Forfeited | | | (27,500 | ) | | | 2.66/1.81 | | | | | | | | | |
| Nonvested at September 30, 2008 | | | 835,925 | | | $ | 1.39/1.00 | | | | | | | | | |
As of September 30, 2008 we expect to recognize $725,000 of unrecognized share-based compensation for our outstanding options over a weighted average period of 1.6 years.
Restricted Stock Awards
In June 2007, we granted 180,665 restricted shares of common stock to our chief executive officer with a weighted average fair value of $1.36 per share and a four year vesting period. In August 2007, we granted 213,196 restricted shares of common stock to non-employee directors with a weighted average fair value of $0.99 and a one year vesting period. As of September 30, 2008, there were a total of 135,499 restricted shares of common stock outstanding for the chief executive officer with unearned compensation of $167,000 which is expected to be earned within 33 months. No restricted shares of common stock were granted during the nine months ended September 30, 2008.
| | Stock Option Valuation Information |
In August 2008, we granted 225,000 stock options to non-employee directors with a weighted average fair value of $0.29 and a one year vesting period. In August 2008 we also granted 50,000 stock options to our chief executive officer and 4,000 stock options to other employees, with a weighted average fair value of $0.31 and a four year vesting period. .
We have estimated the fair value of our share-based compensation using the Black-Scholes option-pricing model. This model requires the use of subjective assumptions that have a significant impact on the fair value estimate. We have based our assumptions regarding expected volatility on the historic volatility of our common stock, the risk-free interest rate on the U.S. Treasury yield curve in effect at the time of grant, and the expected term of options using the “Simplified Method” in accordance with SAB No. 107, Share-Based Payment. The weighted-average estimated fair value of employee stock options granted during the third quarter of 2008 were calculated using the Black-Scholes model and the related weighted-average assumptions:
| | | Three months ended | |
| | | September 30, 2008 | |
| Expected volatility | | | 80.74 | % |
| Risk-free interest rate | | | 3.45 | % |
| Expected term (in years) | | | 7.0 | |
| Expected dividend yield | | | 0.0 | % |
4. | CASH AND CASH EQUIVALENTS AND INVESTMENTS IN AUCTION RATE SECURITIES |
We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Included with cash are cash equivalents of $5.0 million and $0.7 million as of September 30, 2008 and December 31, 2007, respectively. The carrying value of these investments approximates their fair market value due to their short maturity and liquidity.
Investments in auction rate securities have scheduled maturities greater than 90 days at the time of purchase, and are classified as available-for-sale securities and recorded at fair value. Auction rate securities are used by many student-loan providers, municipalities and other governmental authorities to raise cash to fund projects or operations, and money market funds. These auction rate securities all have AAA/aaa credit ratings, consistent with our investment policy guidelines, and have long-term nominal maturities with provisions calling for the interest rates to be reset through periodic auctions every 7 to 28 days. Beginning in February 2008, all of the auction rate securities held by the Company as of September 30, 2008 have experienced failed auctions. An auction failure is not a default. An auction failure means that the parties wishing to sell securities could not because the number of sellers was greater than the number of buyers at the reset dates. The auction rate securities typically have provisions such that the interest rates initially reset at higher percentages upon failure in the auction market, and then adjust so that interest rates average to prevailing market-based percentages for these types of securities. Interest continues to accrue and be paid currently on all of the auction rate securities.
The investment bank which holds NeoPharm’s auction rate securities has estimated the fair value of all of its auction rate securities as of September 30, 2008, including those held in the Company’s account. The fair value of NeoPharm’s auction rate securities was estimated to be $13.5 million, which is $1.2 million less than their $14.7 million cost. Since the timing of the repurchase of the Company’s auction rate securities at par value has been uncertain and dependent on the rate of improvement of market conditions, we have arranged for and fully drawn on a $5.0 million credit facility collateralized by all of the Company’s investments, including its auction rate securities (see note 6 below).
Subsequent to September 30, 2008, we entered into an agreement with the investment bank that holds our auction rate securities, which gives the Company Auction Rate Securities Rights (Rights”) to sell all of our auction rate securities at par value back to the investment bank at any time during the period between June 30, 2010 and July 2, 2012 under the terms of a nontransferable rights offering. This agreement also gives the Company the right to borrow money from the investment bank in the form of a no net cost loan of up to 75% of the fair value of the auction rate securities. The Company is also exploring other alternatives under which it would liquidate its auction rate securities at par value, although it is not known when or to what extent such alternatives will be available. Accordingly, we have reclassified our investments in auction rate securities from a Current Asset to a Non-Current Asset on our Consolidated Balance Sheet as of September 30, 2008.
Based on the Rights, we now have the ability, at a future date, to sell our auction rate securities at par value to the investment bank that holds our auction rate securities. Additionally, we intend to hold these securities until we can sell them at par value, either when the Rights are exercisable, or at an earlier opportunity to do so. Accordingly, the Company considers the decline in the estimated fair value of its investments in auction rate securities to be temporary. As such, we are reporting the decline in estimated fair value, which is considered to be temporary, of $0.4 million and $1.2 million for the three and nine month periods ended September 30, 2008, respectively, as Accumulated Other Comprehensive Income (Loss), a separate component of Shareholders’ Equity, as provided by Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities.
An accrued interest income receivable of $28,000 and $59,000 was included with prepaid expenses and other current assets, and the carrying value of the investments in auction rate securities, as of September 30, 2008 and December 31, 2007, respectively.
Investments in auction rate securities, stated at estimated fair market value, are as follows (in thousands):
| | | September 30, 2008 | | | December 31, 2007 | |
| State government agencies, at par value | | $ | 14,700 | | | $ | 19,700 | |
| Less: temporary decline in estimated fair value (Accumulated Other Comprehensive Loss) | | | (1,224 | ) | | | - | |
| Net estimated fair value of investments in auction rate securities | | $ | 13,476 | | | $ | 19,700 | |
5. | FAIR VALUE MEASUREMENT |
As discussed in Note 1, SFAS 157 became effective for measuring and reporting financial assets and liabilities in our financial statements as of January 1, 2008. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
SFAS 157 establishes a three-level hierarchy for disclosure to show the extent and level of judgment used to estimate fair value measurements:
Level 1 – Uses unadjusted quoted prices that are available in active markets for identical assets or liabilities as of the reporting date.
Level 2 – Uses inputs other than Level 1 that are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data.
Level 3 – Uses inputs that are unobservable and are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.
We have applied the provisions of SFAS 157 to financial assets and liabilities measured at fair value on our consolidated financial statements.
Investments in student loan backed auction-rate securities are our only Level 3 assets and these investments are classified as available-for-sale and recorded at fair value. Because of the recent deterioration in the credit markets, auctions for these securities have failed since the first quarter of 2008. Consequently, fair value measurements have been estimated by the investment bank which holds NeoPharm’s auction rate securities using an income-approach model (discounted cash-flow analysis). The model considers factors that reflect assumptions that market participants would use in pricing similar securities, including, the collateral underlying the investments, the creditworthiness of the counterparty, expected future cash-flows, including the next time the security is expected to have a successful auction, and risks associated with the uncertainties of the current market, the formula applicable to each security which defines the interest rate paid to investors in the event of a failed auction, forward projections of the interest rate benchmarks specified in such formulas, the likely timing of principal repayments; the probability of full repayment considering the guarantees by the U.S. Department of Education of the underlying student loans, guarantees by other third parties, and additional credit enhancements provided through other means, and publicly available pricing data for recently issued student loan asset-backed securities which are not subject to auctions.
Based on the Rights, we now have the ability, at a future date, to sell our auction rate securities at par value to the investment bank that holds our auction rate securities. Additionally, we intend to hold these securities until we can sell them at par value, either when the Rights are exercisable, or at an earlier opportunity to do so. Accordingly, the Company considers the decline in the estimated fair value of its investments in auction rate securities to be temporary. As such, we are reporting the decline in estimated fair value, which is considered to be temporary, of $0.4 million and $1.2 million for the three and nine month periods ended September 30, 2008, respectively, as Accumulated Other Comprehensive Income (Loss), a separate component of Shareholders’ Equity, as provided by Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Any future fluctuations in fair value, including recoveries of previously unrealized losses relating to these investments, would be recorded as Accumulated Other Comprehensive Income (Loss). Any adjustments in fair value that we determine to be other-than-temporary would require us to recognize associated adjustments to earnings. We evaluate financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level at which to classify them for each reporting period.
During the second quarter of 2008, we entered into a credit agreement with the investment bank that holds our auction rate securities that will enable the Company to borrow up to a maximum of $5.0 million in the form of a demand margin loan. Under the terms of the agreement, borrowings are collateralized by the Company’s auction rate securities and other investments and interest is based on an annual rate equal to the sum of the prevailing daily 30-day LIBOR rate plus 25 basis points. This weighted average for this rate was 2.65% for the three months ended September 30, 2008, and as of September 30, 2008, this rate was 3.93%. In June 2008, we borrowed $5.0 million under this credit agreement and invested the proceeds in a short-term money market fund. This $5.0 million loan, along with accrued interest expense, is shown as of September 30, 2008 on our Consolidated Balance Sheet as short-term debt. The $5.0 million proceeds invested in U.S. government treasury bills and short-term money market funds are included in cash and cash equivalents as of September 30, 2008 on our Consolidated Balance Sheet. Interest expense of approximately $30,000 and $42,000 for the three and nine month periods ended September 30, 2008, is included in net interest income in our Condensed Consolidated Statement of Operations.
Subsequent to September 30, 2008, we entered into an agreement with the investment bank that holds our auction rate securities, which gives the Company Auction Rate Securities Rights (Rights”) to sell all of our auction rate securities at par value back to the investment bank at any time during the period between June 30, 2010 and July 2, 2012 under the terms of a nontransferable rights offering. This agreement also gives the Company the right to borrow money from the investment bank in the form of a no net cost loan of up to 75% of the fair value of the auction rate securities, including the $5 million already borrowed (see note 4 above).
We record fixed assets at cost and record depreciation using the straight-line method over the related asset’s estimated useful life. Expenditures that do not extend the life or improve the productivity of assets are charged to expense when incurred. When fixed assets are disposed of, the related costs and accumulated depreciation are removed from the accounts and any gain or loss is recorded. Depreciation and amortization expense for the nine months ended September 30, 2008 and September 30, 2007, was $141,000 and $587,000, respectively. During the nine months ended September 30, 2008, the Company capitalized the cost of leasehold improvements made in connection with its move to a smaller corporate headquarters facility, and laboratory equipment totaling $143,000.
Long-lived assets are reviewed for impairment when changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to estimated undiscounted cash flows expected to be generated by the assets. If the carrying amount of an asset were to exceed its estimated future cash flows, an impairment charge would be recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.
8. | FACILITY CONSOLIDATION COSTS |
The lease on our former Waukegan facility, from which we moved to our new facility in Lake Bluff, expired on March 31, 2008. In this lease there was an obligation when we vacated the premises for us to restore the facility to its original condition when we moved into the facility. As a result, for the year ended December 31, 2007, we accrued an estimated cost of our restoration obligation of $200,000. In April 2008 we entered into an agreement to pay $125,000 to the owner of our former Waukegan facility in lieu of incurring the actual costs for the restoration of that facility. As a result, we recorded a reduction in facility consolidation costs of $75,000 in the first quarter of 2008 to adjust the accrual to the amount that was actually paid in April 2008. During the second quarter of 2008, other immaterial facility consolidation expenses of $11,000 were also incurred.
As a result of Company’s restructuring in 2007 and the planned move into a significantly smaller facility as described above, we recorded a charge during the third quarter of 2007 totaling $296,000 to reduce the carrying value of fixed assets, primarily furniture and fixtures and computers and office equipment, to their estimated net realizable value.
We maintain a Stockholder Rights Plan whereby rights to purchase shares of Series A Participating Preferred Stock become exercisable by our stockholders in the event a non-excluded party acquires, or attempts to acquire, 15% or more of our outstanding common stock.
Manufacturing Commitment--To secure access to manufacturing capacity for the potential manufacture, scale-up of manufacturing and regulatory advancement of Cintredekin Besudotox, we entered into agreements with a contract manufacturing organization. Under the terms of the agreements, we may be obligated to pay half of the committed processing costs, or approximately $2.1 million, should we elect not to utilize such capacity. However, at September 30, 2008, management does not believe that there is a current obligation to pay this amount. Refer to Note 11 for further discussion.
License and Research Agreements—From time to time we enter into license and research agreements with third parties. As of September 30, 2008, we had significant agreements with three parties, as described below.
Georgetown University—We have entered into two license agreements with Georgetown whereby we obtained an exclusive worldwide license to use certain technologies. In exchange for the grant of one of these exclusive licenses that is related to taxane derivatives, we agreed to pay Georgetown a royalty, ranging from 1.25% to 2.50% of any net sales from our products incorporating such technologies as covered by the licensed patents. The royalty will be payable for the life of the related patents. Additionally, we may be obligated to pay $400,000 upon entering into any sublicense agreement and $250,000 upon approval of a New Drug Application, or NDA.
In July 2007, we entered into an exclusive license to use certain antisense technologies covered by certain US patents. In exchange for the grant of this license, we paid Georgetown a non-refundable license issue fee of $10,000 and are liable for yearly maintenance fees of $20,000. In addition, we agreed to pay Georgetown a royalty of 2.75% of net sales from our products incorporating these technologies and 50% of any royalties received from sub licensees. We may also be obligated to make milestone payments totaling $900,000 upon achievement of certain objectives.
National Institutes of Health—We entered into an exclusive worldwide licensing agreement with the NIH in 1997 to develop and commercialize IL13-PE38QQR (Cintredekin Besudotox). The agreement required us to pay NIH a $75,000 non-refundable license issue payment and minimum annual royalty payments of $10,000, which increase to $25,000 after the first commercial sale. The agreement further provides for us to make milestone payments to NIH of up to $585,000 and royalties of up to 3.50% based on any future product sales. We made the first milestone payment of $25,000 to NIH in November 1999 after the filing of the U.S. Investigational New Drug IND application for IL13-PE38QQR. We are required to pay the costs of filing and maintaining product patents on the licensed patents. The agreement extends to the expiration of the last to expire of the patents on the licensed patents, if not terminated earlier. The agreement may be terminated by mutual consent of NIH and us. Either party may terminate if the other party breaches a material term or condition and such breach is not cured within a certain period of time. Also, either party may unilaterally terminate by giving advanced notice.
On May 30, 2006 we entered into a non-exclusive Patent License Agreement with the NIH providing us with a non-exclusive license to utilize a patented process owned by the U.S. government relating to convection enhanced delivery, or CED, for us to use with drugs, including Cintredekin Besudotox in the treatment of gliomas, in the U.S., its territories and possessions. Under the terms of this Patent License Agreement, we have paid NIH a noncredit able, nonrefundable license issue royalty of $5,000 and have agreed to pay a nonrefundable, minimum annual royalty of $2,000, which will be credited against earned royalties, which are fixed at one-half of one percent (0.5%) on aggregate future product sales over $100 million. An additional benchmark royalty of $20,00 is payable within thirty (30) days of receiving approval from the U.S. FDA of approval to use the licensed CED process in administrating a drug for the treatment of gliomas. Pursuant to an amendment to this Patent License Agreement entered into in August 2006, we expanded the field of use to cover the treatment of cancer, were given the right to sublicense our rights and extended the time for us to reach certain benchmarks. In return for these additional rights, we agreed to pay additional sublicensing royalties one and one-half percent (1.5%), to a maximum of $200,000, on the fair market value of any upfront consideration received for granting a sublicense.
In June 2007, we entered into an exclusive worldwide license agreement with the NIH to develop and commercialize IL13-PE38QQR (Cintredekin Besudotox) for use in the treatment of asthma and pulmonary fibrosis. Upon entering the contract, we paid NIH a non-refundable license issue royalty of $125,000 and have agreed to pay an annual royalty of $20,000, which will be credited against earned royalties, which are fixed at four percent (4%) of net sales, including those of sub licensees. In addition, we may be obligated to make milestone payments totaling $1,410,000 upon achievement of certain objectives. We are required to pay the costs of filing and maintaining product patents on the licensed patents. The agreement extends to the expiration of the last to expire of the patents on the licensed patents, if not terminated earlier. The agreement may be terminated by mutual consent of NIH and us. Either party may terminate if the other party breaches a material term or condition and such breach is not cured within a certain period of time. Also, either party may unilaterally terminate by giving advanced notice.
U.S. Food and Drug Administration—In 1997 the Company entered into a Cooperative Research and Development Agreement, or CRADA, with the FDA. Pursuant to the CRADA, we committed to work to commercialize the IL13-PE38QQR chimeric protein which we licensed from NIH. The FDA agreed to collaborate on the clinical development and commercialization of IL13-PE38QQR. In September 2005, we and the FDA agreed to extend the term and funding of the CRADA through July 2009 for $165,000 per year.
Lovelace Respiratory Research Institute—In the third quarter of 2008, the Company entered into an agreement to pay $1.1 million for the performance of a preclinical inhalation toxicology study in non-human primates for our Cintredekin Besudotox IL13-PE38 therapeutic agent for the treatment of pulmonary fibrosis. Under the terms of this agreement, we paid $200,000 upon execution of the agreement, and will pay an additional $500,000 in the fourth quarter of 2008 and the remaining balance upon completion of the final study report in the first quarter of 2009. The payment of $200,000 made during the third quarter of 2008 is included in research and development expense in our Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2008.
Clinical Trial Commitments—As of September 30, 2008, we had clinical trial agreements with various parties, as described below.
Excel Life Science— In August 2007, the Company entered into an agreement with Excel Life Science for the completion of Phase II clinical trials with the use of LEP-ETU for the treatment of metastatic breast cancer. The agreement contains milestone payments which are based upon stages of completion of the phase II clinical trials. Upon entering the contract, we paid Excel Life Sciences $70,000. In March 2008, we began enrolling patients in this phase II clinical trial and we recorded $70,000 in accrued clinical trial expenses at March 31, 2008 for the patient enrollment milestone payment obligation. This patient enrollment milestone obligation was paid in April 2008. Included in accrued clinical trial expenses at September 30, 2008 is $70,000 for patient enrollment expense accrued toward the next milestone payment obligation, for the 12 patients enrolled to-date in this study as of September 30, 2008. The total remaining obligation is potentially $139,000 for the completion of this phase II clinical trial.
TGen Clinical Research Services— In March 2008, we entered into an agreement with TGen Clinical Research Services for the completion of Phase I clinical trials with the use of LE-DT for the treatment of advanced solid tumors. The agreement contains milestone payments which are based upon stages of completion of the phase II clinical trials. Upon entering the contract, we paid $13,000 to TGen Clinical Research Services. Included in accrued clinical trial expenses at September 30, 2008 is $40,000 for patient enrollment expense accrued toward the next milestone payment obligation for the 3 patient enrolled to-date in this study, net of payments made as of September 30, 2008. The total remaining obligation is dependent on the number of patients that are enrolled, and their progression in the phase I study at TGen, but could potentially be $180,000 for the completion of the phase I clinical trial at this site.
Georgetown University— In April 2008, we entered into an agreement with Georgetown University Medical Center for the completion of Phase I clinical trials with the use of LE-DT for the treatment of advanced solid tumors. The agreement contains milestone payments which are based upon stages of completion of the phase II clinical trials. Upon entering the contract, we accrued a start up fee of $9,000 payable to Georgetown University Medical Center. Included in accrued clinical trial expenses at September 30, 2008 is $78,000 for patient enrollment expense accrued toward the next milestone payment obligation, for the 6 patients enrolled to-date in this study as of September 30, 2008. The total remaining obligation is dependent on the number of patients that are enrolled, and their progression in the phase I study at Georgetown, but could potentially be $148,000 for the completion of the phase I clinical trial at this site.
SIRO ClinPharm, USA— In August 2008, we entered into an agreement with SIRO ClinPharm USA (“SIRO”) for the completion of a planned confirmatory Phase III trial with the use of the our drug product candidate Cintredekin Besudotox (IL13-PE38QQR) (“IL-13”), for the treatment of patients suffering from Recurrent Glioblastoma Multiforme (GBM). The agreement provides for the enrollment and management of patients in an initial Part I study of the trial at a total cost to the Company of $828,000, with an option for us to enroll more patients in a Part II study at an additional cost of $755,000. If we do not opt to enroll more patients in the Part II study of the trial, an additional payment of $165,000 will be due for the Part I study of the trial.
Termination and Employment Agreements— On March 23, 2007, the Company terminated the employment of Mr. Guillermo Herrera, its President and Chief Executive Officer. In accordance with his employment agreement, Mr. Herrera was scheduled to receive a salary continuation of approximately $35,400 per month for twelve months. However, subsequent to his termination, the Company determined that, based on the terms of the employment agreement, no salary continuance was due Mr. Herrera and further payments were stopped. Refer to Note 11 for further discussion.
On March 23, 2007, the Company entered into an employment agreement with Mr. Laurence P. Birch (the “Agreement”) to serve as its President and Chief Executive Officer. Mr. Birch was subsequently elected to the Company’s Board of Directors on March 30, 2007. Under terms of the Agreement, Mr. Birch is provided an annual base salary of $275,000 and a target bonus of 50% of his base salary based on performance criteria to be established by the Board in consultation with Mr. Birch, with the potential to earn up to 100% of his base salary for over achievement of performance criteria. In the event the Company terminates Mr. Birch’s employment without cause he would be entitled to receive a continuation of his then current base salary for a period of twelve months. In the event of a termination after a change of control of the Company, Mr. Birch would receive, in addition to twelve months salary continuation, a lump sum payment equal to the prior year’s bonus, if any, plus accelerated vesting of all options or restricted stock.
NeoPharm, Inc. and certain of our former officers have been named in a consolidated amended complaint, which alleges various violations of the federal securities laws in connection with our public statements regarding our LEP drug product candidate during the period from October 31, 2001 through April 19, 2002. On November 4, 2002, we moved to have the complaint dismissed. Our motion to dismiss was granted in part and denied in part in February 2003. In November 2004, the plaintiffs filed a motion to amend and a motion for summary adjudication. The motion to amend sought to include certain pre-class period statements in the complaint. The motion for summary adjudication asked the Court to rule that certain statements made in an arbitration award regarding the LEP drug product candidate be deemed facts established in this proceeding. On February 23, 2007, the Court entered an order denying both the plaintiffs’ motion to amend and the plaintiffs’ motion for summary adjudication. Fact and expert discovery is closed. On March 21, 2008, the dispositive motion filing deadline, NeoPharm filed a motion for summary judgment, on which we are awaiting the court’s decision. No trial date has yet been set. We intend to vigorously defend each and every claim in the complaint. Management is unable to estimate the potential outcome or range of possibilities, if any. In addition, we maintain insurance coverage to mitigate the financial impact of any potential loss.
The employment of Mr. Guillermo Herrera, the former CEO of the Company, was terminated effective March 23, 2007. Since that date, he has retained counsel and on May 7, 2007, Mr. Herrera’s attorney filed a suit entitled Guillermo Herrera vs. NeoPharm, Inc., Case No. 2007 L 004711 in the Circuit Court of Cook County, Illinois, seeking payment of $212,500 for his 2006 bonus and $25,000 for a salary increase for 2007. Subsequent to this filing, the Company determined that under the terms of his employment agreement the Company should not be responsible for the payment of severance and terminated further payments. Mr. Herrera filed an Amended Complaint on February 21, 2008 alleging breach of his employment agreement with the Company, defamation, and tortious presentation of the plaintiff in a false light. Mr. Herrera seeks an additional $363,612 representing the remaining severance payments, plus attorneys’ fees and costs. Mr. Herrera also seeks unspecified compensatory and punitive damages. The Company is vigorously defending this matter. We are unable at this time to make any prediction as to the outcome of this litigation.
We entered into various contractual arrangements, primarily during the fourth quarter of 2006, under take or pay agreements, with Diosynth Biotechnology, Inc. (“Diosynth”), to secure access to manufacturing capacity for the potential manufacture and regulatory advancement of Cintredekin Besudotox through early 2008. As a result of the FDA’s decision to require additional Phase III clinical testing of Cintredekin Besudotox, the Company advised Diosynth that the timing of further work to support a potential BLA submission must be delayed. Diosynth has indicated that such a delay constitutes a default under our contract. In response, the Company invoked the dispute resolution provisions of the contract in an attempt to resolve these and other differences between the two companies. A dialogue between the senior executives of our Company and Diosynth while initiated, has not been pursued by the parties. In the event the parties fail to resolve their differences, the contract provides for mediation and eventually binding arbitration. Under the terms of the various contractual arrangements, if the Company can not settle its outstanding differences with Diosynth, and Diosynth should refuse to delay the related disputed manufacturing activity, and such dispute were to culminate in an arbitration judgment against the Company, we may be obligated to pay half of the disputed processing costs. The Company estimates the potential exposure to be approximately $2.1 million at September 30, 2008.
We are from time to time subject to claims and litigation arising in the ordinary course of business. We intend to defend vigorously any such litigation that may arise under all defenses that would be available to us. In the opinion of management, the ultimate outcome of those proceedings of which management is aware, even if adverse to us, will not have a material adverse effect on our consolidated financial position or results of operations. While we maintain insurance to cover the use of our drug product candidates in clinical trials, we do not presently maintain insurance covering the potential commercial use of our drug product candidates and there is no assurance that we will be able to obtain or maintain such insurance on acceptable terms.
Subsequent to September 30, 2008, we entered into an agreement to sell all of our auction rate securities at par value, to the investment bank that holds our auction rate securities, at any time during the period between June 30, 2010 and July 2, 2012 under the terms of a nontransferable rights offering .. This agreement also gives the Company the right to borrow money from the investment bank in the form of a no net cost loan of up to 75% of the market value of the auction rate securities (see note 4 above).
| MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Any statements made by NeoPharm, Inc. (“we”, “us”, “our”, or the “Company”) in this quarterly report that are forward-looking are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We caution readers that important factors may affect our actual results and could cause such results to differ materially from forward-looking statements made by or on our behalf. Such factors include, but are not limited to, those risks and uncertainties relating to difficulties or delays in development, testing, manufacturing, regulatory approval, recruitment of patients, production and marketing of the Company’s drug candidates, including, but not limited to: our drug product candidate IL13-PE38QQR, or Cintredekin Besudotox, and our NeoLipid® product candidates LE-SN38, LEP-ETU, LE-DT and LE-rafAON; our ability to make, or the timing of, a filing of any Biologics License Application, or BLA, for approval of Cintredekin Besudotox with the United States Food and Drug Administration, or FDA; our ability to conserve our cash resources, to implement reductions in general and administrative expenditures and to obtain additional sources of financing in the future; the performance of third-party contractors; uncertainty regarding the outcome of certain pending class action and other outstanding litigation; unexpected adverse side effects or inadequate therapeutic efficacy of our drug product candidates, including, but not limited to, Cintredekin Besudotox, that could slow or prevent our drug product candidates coming to market; the uncertainty of patent protection for our intellectual property and trade secrets, including freedom to operate with any of our drug product candidates and the uncertainty of maintenance of our trade secrets; our ability to raise additional funds at all or on terms acceptable to us; and other factors referenced under Item 1A, “Risk Factors” in Part II of this Quarterly Report on Form 10-Q.
The following should be read in conjunction with our condensed consolidated financial statements and related notes and with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Risk Factors section included as Item 1A herein and in the Company’s 2007 Annual Report on Form 10-K. The results discussed below are not necessarily indicative of the results to be expected in any future periods. The following discussion contains forward-looking statements that are subject to risks and uncertainties, which could cause actual results to differ from statements made.
Overview
We are a biopharmaceutical company engaged in the research, development, and commercialization of drugs for the treatment of various cancers and other diseases. Our corporate office and research and development facility is located in Lake Bluff, Illinois and we had 20 active employees as of September 30, 2008. We have built our drug development program around our two proprietary technology platforms: a tumor-targeting toxin platform and NeoLipid® liposomal drug delivery system. We have advanced five drug product candidates in various stages of clinical and pre-clinical development for the treatment of cancer and one drug product candidate in pre-clinical development for treatment of interstitial pulmonary fibrosis, or IPF, and asthma. The following table summarizes key information about our current drug product candidate pipeline:
| Drug product candidate | | Clinical indication(s) | | 2008 Clinical development status | | | Commercialization rights |
| | | | | | | | |
Cintredekin Besudotox (IL13-PE38QQR) | Glioblastoma multiforme (brain cancer) | Completed Phase III (1) | World wide |
| | | | | | | | |
LEP-ETU (Liposomal Paclitaxel) | Breast cancer, ovarian cancer and other solid tumors | Phase II (2) | | | World wide |
| | | | | | | | |
LE-SN38 (Liposomal SN-38) | Colorectal cancer and other solid tumors | Phase II (3) | | | World wide |
| | | | | | | | |
LE-DT (Liposomal Docetaxel) | Breast cancer, ovarian cancer, prostate cancer and other solid tumors | Phase I (4) | | | World wide |
| | | | | | | | |
LE-rafAON (Liposomal-raf-Antisense Oligonucleotide) | Pancreatic and prostate cancer | Re-activate IND, Planning Phase I/Phase II in Pancreatic Cancer | United States |
| | | | | | | | |
Cintredekin Besudotox (IL13-PE38QQR) | Interstitial pulmonary fibrosis and asthma | Pre-IND (5) | | | World wide |
_________________________
| (1) | Representatives of the United States Food and Drug Administration’s, or FDA, Office of Oncology indicated during a review of the clinical data with the Company in March 2007, that an additional Phase III confirmatory clinical trial for Cintredekin Besudotox in the treatment of glioblastoma multiforme, or GBM, would be required before the FDA could accept the Company's Biologics License Application, or BLA. The Company has signed an agreement with a clinical research organization to oversee an initial Phase III confirmatory trial regarding Cintredekin Besudotox, which is further discussed below under the heading “Drug Product Candidate Summary - Cintredekin Besudotox.” |
| (2) | The Company announced on March 31, 2008 that it had enrolled its first patients in its multi-center open-label, Phase II clinical trial of Liposomal Paclitaxel (LEP-ETU) for efficacy and safety in patients with Metastatic Breast Cancer. |
| (3) | The Company announced in March 2007 that the interim analysis of data following the completion of treatment of the first 21 patients demonstrated disease stabilization, but the study for LE-SN38 did not achieve the primary tumor response endpoint. The Company is reassessing project next steps including additional data analyses and the possibility of other studies related to lung and breast cancer. |
| (4) | The Company entered into agreements with TGen Clinical Research Services and Georgetown University in March 2008 and April 2008, respectively, for the completion of Phase I clinical trials with the use of LE-DT for the treatment of advanced solid tumors. Patient enrollment in this Phase I clinical trial with LE-DT to define the toxicities, pharmacokinetics and maximum tolerated dose with this new modality of treatment began in the second quarter of 2008. |
| (5) | The Company entered into an agreement with Lovelace Respiratory Research Institute in the third quarter of 2008 for the completion of a two week inhalation toxicology study designed to provide a detailed preclinical evaluation of this product through nebulization to fully characterize the physio-chemical behavior of the nebulized product. |
To date, we have not received FDA approval for any of our drug product candidates. We expect to continue to incur losses for the foreseeable future as we continue our research and development activities, which include the sponsorship of human clinical trials for our drug product candidates. Until we are able to successfully commercialize one or more of our drug product candidates, we anticipate that we will be required to fund our research and development activities primarily by other means, including, but not limited to, issuing equity or other securities, licensing drug product candidates to third parties and collaborating with third parties to develop formulations of their compounds using our technology.
Drug Product Candidate Summary
Cintredekin Besudotox
Cintredekin Besudotox (GBM)
The drug product candidate which we have advanced the farthest is Cintredekin Besudotox, a tumor-targeting toxin being developed as a treatment for glioblastoma multiforme, or GBM, a deadly form of brain cancer.
We have exclusively licensed Cintredekin Besudotox from the NIH and the FDA, and have been developing this drug product candidate under a Cooperative Research and Development Agreement, or CRADA, with the FDA Center for Biologics Evaluation and Research, or CBER. Cintredekin Besudotox has received orphan drug designation in the US and Europe and FDA has designated it for the fast track drug development program. In addition, Cintredekin Besudotox has been selected to participate in the FDA’s Continuous Marketing Application, CMA, Pilot 2 program. We also hold a non-exclusive license to utilize a patented process owned by the U.S. government relating to convection enhanced delivery, or CED, for use with drugs, including Cintredekin Besudotox in the treatment of gliomas.
We have also signed a Cooperative Research and Development Agreement (the “NINDS CRADA”) with the National Institute of Neurological Diseases and Stroke (“NINDS”) for research on a therapeutic agent for untreatable brain diseases in humans. Under the terms of the NINDA CRADA, NINDS, which is part of the NIH, will deliver NeoPharm’s proprietary drug, Cintredekin Besudotox in conjunction with a surrogate marker via NINDS’ patented methodology of Convection Enhanced Delivery (CED), which was previously licensed to NeoPharm. The Company will provide both the drug and technical resources to study its effects in various brain cancers in humans.
Conventional, non-specific chemotherapeutic drugs attack cancer cells by stopping them from dividing and reproducing, but can also damage normal healthy cells because they do not discriminate between cancerous and healthy cells. Furthermore, standard chemotherapy drugs are usually administered systemically, which leads to their distribution throughout the body rather than to one area, such as a tumor in the brain. Common side effects of chemotherapy that are caused by damage to bone marrow include the body’s inability to produce enough red blood cells, causing weakness and fatigue; white blood cells, lowering the body’s resistance to infections; or platelets, preventing blood from clotting properly, which can lead to excessive bleeding.
Cintredekin Besudotox is being developed as a highly specific tumor-targeting agent. Cintredekin Besudotox is a recombinant protein consisting of a single molecule composed of two parts: a tumor-targeting molecule and a cytotoxic agent. The targeting component consists of interleukin-13(IL-13), an immune regulatory cytokine. Malignant glioma cells, as compared to normal brain cells, express IL-13 receptors at a higher density. The cytotoxic agent is a potent bacterially derived toxin called PE38. Cintredekin Besudotox is designed to detect and bind IL-13 receptors on the surface of malignant glioma cells and selectively deliver PE38 to destroy tumor cells. Cintredekin Besudotox is administered by a technique known as convection-enhanced delivery, or CED, in which the drug is delivered through catheters inserted in brain tissue surrounding the tumor (peritumoral administration) or into the tumor (intratumoral administration) following surgical resection of the tumor. CED is designed to infuse Cintredekin Besudotox directly to the tumor site and adjacent brain tissue with the goal of killing resident tumor cells and preventing recurrence of tumor cell growth. We hope to show that this method of delivery minimizes both damage to the surrounding cells and toxicity from systemic drug exposure.
During 2006 and the first quarter of 2007, the Company primarily focused on completing its Phase III trial and commercialization strategy for Cintredekin Besudotox, including the preparation of the corresponding BLA submission to the FDA. However, upon review of the results from the Company’s Phase III PRECISE trial in March 2007, the FDA concluded that an additional Phase III confirmatory trial would be required prior to acceptance of a potential BLA filing by the Company. This will substantially delay, and may even prevent, the potential commercialization of the product.
The Company has entered into an agreement with a clinical research organization to oversee an initial Phase III confirmatory trial with the primary objective of overall survival, with a secondary objective of progression free survival for patients with recurrent GBM against the standard of care. The Company is expecting to start enrolling patients in the fourth quarter of 2008. If the results of such an initial confirmatory trial were to be encouraging, the Company could elect to expand the trial into a larger Phase III trial in order to support a possible BLA filing for Cintredekin Besudotox with the FDA. While the Company has sufficient resources to fund the initial Phase III confirmatory trial, and evaluate possible drug activity, additional funding from sources outside the Company would be necessary to expand and then complete the necessary Phase III trial, make the BLA filing and advance this drug product candidate. The Company does not currently have the financial reserves to fully fund the testing and obtain approval for any of its drug product candidates, including, but not limited to, Cintredekin Besudotox. Even if third party financing were to become available, and at this time no assurance can be given that it would be, there can be no assurance given that the terms of any proposed third party financing arrangement would be acceptable to the Company. The Company continues to explore drug delivery improvements as well as the possibility of genetic testing to identify patients that might be more responsive to treatment. There can be no assurance that these modifications will result in a positive outcome in a second Phase III trial. Further, there can be no assurances the data from a second Phase III trial, whether or not these modifications were made, would be deemed acceptable by the FDA or that the FDA would approve a BLA for Cintredekin Besudotox based on such data.
The Company continues to evaluate the potential of Cintredekin Besudotox for the treatment of recurrent GBM. There can be no assurance that, if a second Phase III trial were completed, data evidencing statistical superiority would be generated and, even if such data were generated and produced to the FDA, there can be no assurance that the FDA would accept or approve a BLA submission by the Company.
Cintredekin Besudotox( IPF and Asthma)
The Company has licensed IL13-PE38 from NIH, FDA, and University of Michigan as a potential therapeutic agent for the treatment of pulmonary fibrosis and asthma. The Company’s collaborators have completed extensive preclinical studies in animal models for the control and reversal of pulmonary fibrosis with this agent. Preclinical studies relating to asthma have also been performed. Other preclinical toxicology studies are also underway. The Company is moving forward with its plan to undertake additional detailed preclinical evaluation of this. In the third quarter of 2008, the Company entered into an agreement for the performance of a two week inhalation toxicology study with a two week recovery period in non-human primates. This study is designed to provide a detailed preclinical evaluation of this product through nebulization to fully characterize the physio-chemical and biological behavior of the nebulized product. The Company plans to submit an IND to the FDA in the first quarter of 2009 if those studies show that it is reasonably safe to conduct clinical investigations in humans. The preclinical testing plan has been discussed with the FDA, and the agency has made it clear that significant studies must be performed in animals to explore potential side effects in humans, before the agency will permit testing in humans.
NeoLipid® Platform
LE-SN38
LE-SN38 is our NeoLipid® liposomal formulation of SN-38, the active metabolite of Camptosar® (Pfizer Inc.), a chemotherapeutic pro-drug, which is used as a first-line and second-line colorectal cancer treatment. At the present time, without the NeoLipid® system, SN-38 is insoluble and can only be used to treat cancer by administering the pro-drug Camptosar®. A pro-drug is a compound that is converted into the active drug in the body. However, Camptosar® is converted into SN-38 in the liver at different rates by different patients, and this variability in conversion rates can result in suboptimal dosing and adverse side effects, such as severe diarrhea. We hope to show that our proprietary NeoLipid® technology permits delivery of SN-38 to the tumor cells without the need for conversion, therefore minimizing variability and optimizing dose with minimal side effects.
Results from our 2004 Phase I clinical trial provided evidence of the safety and tolerability of LE-SN38 and established a maximum tolerated dose (MTD) of 35 mg/m2 for all but a small subset of patients who metabolize SN-38 slowly. Pharmacokinetic analysis of blood samples from patients treated with LE-SN38 showed that blood levels and systemic drug exposure to SN-38 were comparable to or greater than that expected from the marketed Camptosar® dose based on previously published studies.
During the second quarter of 2006, in conjunction with the Cancer and Leukemia Group B, CALGB, we initiated enrollment in a Phase II clinical trial with LE-SN38 in metastatic colorectal cancer patients, and completed enrollment of the 21st patient in December, 2006.
In March 2007, the Company announced that the interim analysis of data following the completion of treatment of the first 21 patients demonstrated disease stabilization, but the study did not achieve the primary tumor response endpoint. The Company is reviewing the data and, in particular, examining the patients’ demography, prior chemotherapy exposure, advanced stage of the disease, and other related factors. It is possible that patients who were enrolled in this trial were exposed to other chemotherapy regimens prior to enrolling and that this prior exposure may be the reason the study did not achieve its primary endpoint. The Company is also assessing the potential next steps for this project which may include additional data analyses and the possibility of other studies related to lung cancer and breast cancer with LE-SN38.
LEP-ETU
LEP-ETU is our NeoLipid® liposomal formulation of the widely used cancer drug, paclitaxel. Paclitaxel, also known as Taxol® (Bristol-Myers Squibb Company), has been approved in the US for the treatment of ovarian, breast and lung cancers. Despite paclitaxel’s wide use and its tumor cytotoxic characteristics, its effectiveness can be limited by its adverse side effects, which can include nausea, vomiting, hair loss and nerve and muscle pain. Because of the chemical characteristics of paclitaxel, it cannot be introduced into the body unless it is first formulated in a mixture of castor oil (Cremophor®) and ethanol, which can lead to significant side effects such as hypersensitivity reactions and cardiac toxicities. We hope to show that our proprietary NeoLipid® technology, which eliminates the need for Cremophor and ethanol, permits delivery of paclitaxel treatment with fewer side effects.
During 2004, we completed a Phase I clinical trial for LEP-ETU. In this study, LEP-ETU appeared to be well tolerated in the majority of the patients. Antitumor activity was observed, with 16% of patients experiencing partial responses (shrinkage of tumor by 50% or more). Additionally, 44% of patients evidenced stable disease and were able to complete 4 or more, 3-week cycles of LEP-ETU treatment. Patients previously treated with taxanes were among those who partially responded to LEP-ETU.
Based on the results obtained in its Phase I trial, the Company began patient enrollment in the first quarter of 2008 in five centers in a Phase II trial designed to assess the efficacy and safety of LEP-ETU in recurrent breast cancer patients. Twelve patients have been enrolled as of end of the third quarter of 2008. This study is expected to be completed by the end of 2008 or early 2009. Depending on the outcome of this clinical trial, we may decide to undertake multicenter and multinational Phase III trials in this indication after thorough discussions with FDA.
LE-DT
Pre-clinical work has also advanced on our earlier stage liposomal formulation of the anti-cancer agent docetaxel, LE-DT, which is the active ingredient in Sanofi Aventis’ Taxotere® which is approved for use in certain breast cancer, non-small cell lung cancer, gastric adenocarcinoma, head and neck cancer indications and prostate cancer. We filed the Investigational New Drug Application, IND, to the FDA in December 2007 and the IND became effective in January 2008. Following the activation of its IND, the Company started enrolling patients in two cancer centers, Georgetown University, Lombardi Cancer Center and at TGen, Scottsdale Health Care system. These two Centers have thus far enrolled nine patients in this trial, which is designed to define the maximum tolerated dose (MTD) of LE-DT in patients with metastatic solid cancer who have failed conventional therapy, as of the third quarter of 2008. This study is expected to be completed by the end of 2008 or early 2009.
LE-rafAON
Preclinical work with the new formulation of LE-rafAON, which is expected to have minimal infusion related toxicities, is ongoing and we expect to submit a revised IND to FDA in the fourth quarter of 2008. The antisense oligonucleotide agent c-raf has shown significant down regulation of the gene in Preclinical studies. Also, LE-rafAON has exhibited significant radiation sensitization and chemo sensitization with other anticancer agents such as gemcitabine and paclitaxel in human xenograft models in mice in pancreatic and prostate tumors. We plan to perform the bridging Phase I trial with this newly formulated LE-rafAON and thereafter start Phase II trials in pancreatic and prostate cancer models where this gene seems to be potentially over expressed.
We intend to further develop the NeoLipid® drug product candidates by using our internal resources and by continuing to collaborate with other companies and leading governmental and educational institutions.
In addition, we intend to explore the use of our proprietary NeoLipid® liposomal drug delivery technology to create new products in two ways: life cycle management, therefore extending the patent life and/or modifying the pharmacokinetic profile of existing cancer drugs, and by utilizing our platform to develop new drugs. We are aware of several widely used cancer drugs that are nearing patent expiration, as well as other widely used cancer drugs with patents that have expired. When a drug is combined with another agent or delivery system in a novel way, its patent life may be extended. Additionally, while many chemotherapeutic drugs have been effective for the treatment of cancer, these drugs have been limited in their use because of adverse side effects and difficulties in administration. Our NeoLipid® drug delivery technology may increase the usefulness of these compounds as improved anti-cancer treatments. Finally, we believe that our liposomal drug delivery technology may provide us with a platform for the development of novel therapeutic agents for cancer drug development.
It is difficult to predict with any certainty the timing of and total estimated costs to complete development of drug product candidates in early stage, or Phase I, clinical development, as well as the estimated date such drug product candidates would be available for sale, if approved by the FDA. A number of factors contribute to this uncertainty, including: side effects encountered in early stage clinical trials, ability to scale up manufacturing for commercial supply, and the fact that the size and scope of pivotal Phase III clinical trials are unknown until sufficient data is available to present a Phase III plan to the FDA for approval. In addition, our drug product candidates require approval by the FDA after completing Phase III clinical trials before we can sell the drugs to generate revenue and, potentially, realize net cash inflows. Substantial additional clinical trial expenses are expected to be incurred for Cintredekin Besudotox before approval can be sought again.
The table below includes a summary of identified direct project costs incurred to date for our clinical research and development projects. Generally, identified project costs include expenses incurred specifically for clinical trials and pre-clinical studies we conduct, and exclude expenses incurred for salaries paid to our professional staff, our Lake Bluff facility and the related depreciation of equipment as well as general laboratory supplies used in our research, which are included with non-project specific costs.
| | | Total Direct Costs Incurred | |
| Research Project | | Three Months Ended September 30, 2008 | | | Nine Months Ended September 30, 2008 | | | Since Beginning of Project | |
| | | | | | | | | | |
| Cintredekin Besudotox | | $ | 293,000 | | | $ | 437,000 | | | $ | 67,945,000 | |
| LEP-ETU | | | 43,000 | | | | 214,000 | | | | 8,004,000 | |
| LE-SN38 | | | 1,000 | | | | 10,000 | | | | 5,325,000 | |
| LE-DT | | | 90,000 | | | | 206,000 | | | | 751,000 | |
| LE-rafAON | | | 137,000 | | | | 345,000 | | | | 416,000 | |
| Non-project specific and other | | | 890,000 | | | | 2,079,000 | | | | N/A | |
| | | | | | | | | | | | | |
| Total research and development expenses | | $ | 1,454,000 | | | $ | 3,291,000 | | | | N/A | |
Results of Operations
Three Months Ended September 30, 2008 as compared to Three Months Ended September 30, 2007
Research and development, or R&D, expense for the three months ended September 30, 2008 decreased by $0.2 million, to $1.5 million, compared to $1.7 million for the same period in 2007. The decrease is attributed to a $0.3 million decrease in overall project costs, partially offset by a $0.1 increase in payroll and benefits expenses. The overall increase in payroll and benefits expenses is primarily attributed to increases in payroll and benefits expenses in 2008 for personnel who support the Company’s advancement of its current clinical trials. The decrease in overall project costs is primarily attributed to a decrease in the PRECISE trial expenditures in connection with the decision to bring that phase III trial to an early conclusion, which was partially offset by the advancement of certain of our NeoLipid® products into clinical trials from a pre-clinical status.
Selling, general, and administrative, or SG&A, expenses decreased $0.2 million, to $1.1 million for the three months ended September 30, 2008, compared to $1.3 million for the same period in 2007. The overall decrease in SG&A is primarily attributed to the Company’s various cost reduction initiatives implemented during 2007. With the move into a smaller, more cost-effective facility and other various cost containment measures that were put into effect, the Company has been able to realize reductions in spending in accounting, legal, consulting, travel expenses, equipment lease costs, board of director compensation, and office supplies totaling $0.3 million.
In the three months ended September 30, 2007, we recorded facility consolidation costs of $0.3 million to reduce the carrying value of fixed assets, primarily furniture and laboratory equipment, to their estimated net realizable value.
In the three months ended September 30, 2007, we recorded other income of $2.0 million dollars in recognition of an amount that had been recorded in deferred income. The Company received notification in September 2007, that Nippon Kayaku Co, Ltd had elected to terminate the licensing agreement they had entered into with the Company in 2004 for which they had paid to the Company a non-refundable license fee of $2.0 million. This amount had been recorded as deferred income at that time.
The Company generated interest income on cash equivalents and short-term investments net of interest expense on short term borrowings of approximately $0.1 million and $0.3 million for the three months ended September 30, 2008 and September 30, 2007, respectively. The decrease in net interest income during the period was primarily due to a decrease in average short-term investment balances which were used to fund operations, and a temporary decrease in the yields on the Company’s short-term investment balances, in connection with the failed auctions of the Company’s auction rate securities.
Nine Months Ended September 30, 2008 as compared to Nine Months Ended September 30, 2007
Research and development, or R&D, expense for the nine months ended September 30, 2008 decreased by $2.9 million, to $3.3 million, compared to $6.2 million for the same period in 2007. The decrease is attributed to a $.5 million reduction in payroll and benefits expenses, primarily attributed to the Company’s various cost reduction initiatives implemented during 2007 and a $2.4 million decrease in overall project costs. The decrease in overall project costs is primarily attributed to decreases in the PRECISE trial and Initial Diagnosis GBM Phase I trial expenditures and product manufacturing and testing related costs in connection with decision to bring the PRECISE trial to an early conclusion, which was partially offset by the advancement of our NeoLipid® products into clinical trials from a pre-clinical status. Product manufacturing and testing related costs, research supplies and lab facility expenses decreased by a combined $1.3 million as a result of these changes in our drug development activities and the Company’s move into a smaller, more cost-effective lab facility.
Selling, general, and administrative, or SG&A, expenses decreased $2.5 million, to $3.6 million for the nine months ended September 30, 2008, compared to $6.1 million for the same period in 2007. Included in this $2.5 million of total SG&A for the nine months ended September 30, 2008 are one-time, non-recurring expenses of $0.2 million related to the Company’s move into smaller, more cost-effective facility. The overall decrease in SG&A is attributed to a $1.0 million decrease in personnel costs, primarily attributed to the Company’s various cost reduction initiatives implemented during 2007, and includes $0.4 million in costs associated with the termination of the Company’s former Chief Executive Officer in March, 2007. With the reduction in people and cost containment measures put into effect, the Company has been able to realize reductions in spending in accounting, legal, patent, consulting, travel expenses, equipment lease costs, board of director compensation, and office supplies totaling $1.5 million.
Following the Company’s announcement in March 2007 that additional Phase III clinical trials have been recommended for its drug product candidate, Cintredekin Besudotox, the Company initiated an organizational realignment in April 2007 which reduced the workforce by 25 employees resulting in a charge to earnings totaling approximately $555,000.
The lease on our Waukegan facility, from which we are moved to our new facility in Lake Bluff, expired on March 31, 2008. The Waukegan lease imposed an obligation on us to restore the facility to its original condition when we vacated the facility. As a result, for the year ended December 31, 2007, we accrued an estimated cost of our restoration obligation of $200,000. In April 2008 we entered into an agreement to pay $125,000 to the owner of our former Waukegan facility in lieu of the actual restoration of that facility. As a result, we recorded a reduction in facility consolidation costs of $75,000 in the first quarter of 2008 to adjust the accrual to the amount that was actually paid in April 2008, which was then partially offset by other immaterial facility consolidation costs incurred in the second quarter of 2008.
In connection with the Company’s restructuring in 2007, we recorded facility consolidation costs of $0.3 million for the nine months ended September 30, 2007, to reduce the carrying value of fixed assets, primarily furniture and laboratory equipment, to their estimated net realizable value.
The Company recorded other income of $2.0 million dollars for the nine months ended September 30, 2007, in recognition of an amount that had been recorded in deferred income. The Company received notification in September 2007, that Nippon Kayaku Co, Ltd had elected to terminate the licensing agreement they had entered into with the Company in 2004 for which they had paid to the Company a non-refundable license fee of $2.0 million. This amount had been recorded as deferred income at that time.
The Company sold clinical equipment returned from the PRECISE trial that has been expensed in a prior year, and realized a $0.3 million gain for the nine months ended September 30, 2008.
The Company generated interest income on cash equivalents and short-term investments net of interest expense on short term borrowings of approximately $0.5 million and $1.1 million for the nine months ended September 30, 2008 and September 30, 2007, respectively. The decrease in interest income during the period was primarily due to a decrease in average short-term investment balances which were used to fund operations, and a temporary decrease in the yields on the Company’s short-term investment balances, in connection with the failed auctions of the Company’s auction rate securities (see Note 4).
Liquidity and Capital Resources
Net cash used in operating activities decreased $9.5 million from $15.0 million to $5.5 million for the Nine months ended September 30, 2008 and September 30, 2007, respectively. The decrease in cash used by operations was primarily a result of the lower net loss for the quarter ended September 30, 2008 compared to September 30, 2007, and a significant reduction in accounts payable balances due to a reduction in overall operations.
Our primary source of cash has been proceeds from sales of marketable securities and in the second quarter of 2008, borrowings under our credit agreement .. As of September 30, 2008, we had available for sale securities with an estimated fair value of $13.5 million, consisting solely of state government auction rate securities. All of the auction rate securities held by the Company as of September 30, 2008 have experienced failed auctions. An auction failure is not a default. An auction failure means that the parties wishing to sell securities could not because the number of sellers was greater than the number of buyers at the reset dates. The auction rate securities typically have provisions such that the interest rates initially reset at higher percentages upon failure in the auction market, and then adjust so that interest rates average to prevailing market-based percentages for these types of securities. Interest continues to accrue and be paid currently on all of the auction rate securities.
The investment bank which holds NeoPharm’s auction rate securities has estimated the fair value of all of its auction rate securities as of September 30, 2008, including those held in the Company’s account. The fair value of NeoPharm’s auction rate securities was estimated to be $13.5 million, which is $1.2 million less than their $14.7 million cost. Since the timing of the repurchase of the Company’s auction rate securities at par value has been uncertain and dependent on the improvement of market conditions, we have arranged for and fully drawn on a $5.0 million credit facility collateralized by all of the Company’s investments, including its auction rate securities.
Subsequent to September 30, 2008, we entered into an agreement that gives us the right to sell all of our auction rate securities at par value, to the investment bank that holds our auction rate securities, at any time during the period between June 30, 2010 and July 2, 2012, under the terms of a nontransferable rights offering. This agreement also gives the Company the right to borrow money from the investment bank in the form of a no net cost loan of up to 75% of the market value of the auction rate securities, which we believe will provide us the liquidity to fund our operations through most of 2009, based on our current forecasted cash consumption during that period of time.
Based on the Rights, we now have the ability, at a future date, to sell our auction rate securities at par value to the investment bank that holds our auction rate securities. Additionally, we intend to hold these securities until we can sell them at par value, either when the Rights are exercisable, or at an earlier opportunity to do so. Accordingly, the Company considers the decline in the estimated fair value of its investments in auction rate securities to be temporary. As such, we are reporting the decline in estimated fair value, which is considered to be temporary, of $0.4 million and $1.2 million for the three and nine month periods ended September 30, 2008, respectively, as Accumulated Other Comprehensive Income (Loss), a separate component of Shareholders’ Equity, as provided by Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities.
We expect that our primary use of cash over the next 12 to 18 months will be to fund, in addition to general and administrative expenses, our initial Phase III confirmatory trial for Cintredekin Besudotox for glioblastoma multiforme, advancement of our Cintredekin Besudotox for pulmonary fibrosis and our NeoLipid® clinical and pre-clinical research and development efforts, and our remaining PRECISE Phase III clinical trial patient obligations.
As a result of the April 2007 cost reduction initiative coupled with other ongoing cost-saving initiatives, the Company was able to reduce budgeted selling, general and administrative expenditures by $2.5 million for the nine months ended September 30, 2008 as compared to September 30, 2007. The Company currently projects it has sufficient cash available to fund operations for 2008 and well into 2009 before requiring additional financing. The date as to which sufficient funds continue to be available for operations, without additional financing, may vary depending upon the timing and implementation of various strategies under consideration by the Company.
We may seek to meet future funding requirements through public or private offerings of securities or with collaborative or other development or licensing arrangements with corporate or private venture partners. Additional financing may not be available when needed or on terms acceptable to us, if at all. If adequate financing is not available, we may be required to further delay, scale back, or eliminate certain of our research and development programs, relinquish rights to certain of our technologies, drugs or products, or license our products or technologies to third parties that we would otherwise seek to develop ourselves.
We have no exposure to off-balance sheet arrangements, no special purpose entities, or activities that include non-exchange-traded contracts accounted for at fair value.
Critical Accounting Policies
In preparing the Company’s financial statements in conformity with U.S. generally accepted accounting principles, management must make a variety of decisions which impact the reported amounts and related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied, the assumptions on which to base accounting estimates and the consistent application of those principles. Due to the type of industry in which we operate and the nature of our business, the following policies are those that management believes are the most important to the portrayal of our financial condition and results and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
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.
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.
We account for share-based compensation in accordance with SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS 123(R). Under the provisions of SFAS 123(R), share-based compensation cost is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes option-pricing model and is recognized as expense over the requisite service period. We also use the Black-Scholes model to estimate the fair value of non-employee options grants that are revalued each quarter. The Black-Scholes model requires various highly judgmental assumptions including volatility and expected option life. If any of the assumptions used in the Black-Scholes model change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period.
Available for Sale Securities
Investments in auction rate securities have scheduled maturities greater than 90 days at the time of purchase, and are classified as available-for-sale securities and recorded at fair value. Auction rate securities are used by many student-loan providers, municipalities and other governmental authorities to raise cash to fund projects or operations, and money market funds. These auction rate securities all have AAA/aaa credit ratings, consistent with our investment policy guidelines, and have long-term nominal maturities with provisions calling for the interest rates to be reset through periodic auctions every 7 to 28 days. Beginning in February 2008, all of the auction rate securities held by the Company as of September 30, 2008 have experienced failed auctions. An auction failure is not a default. An auction failure means that the parties wishing to sell securities could not because the number of sellers was greater than the number of buyers at the reset dates. The auction rate securities typically have provisions such that the interest rates initially reset at higher percentages upon failure in the auction market, and then adjust so that interest rates average to prevailing market-based percentages for these types of securities. Interest continues to accrue and be paid currently on all of the auction rate securities.
The investment bank which holds NeoPharm’s auction rate securities has estimated the fair value of all of its auction rate securities as of September 30, 2008, including those held in the Company’s account. The fair value of NeoPharm’s auction rate securities was estimated to be $13.5 million, which is $1.2 million less than their $14.7 million cost. Since the timing of the repurchase of the Company’s auction rate securities at par value has been uncertain and dependent on the rate of improvement of market conditions, we have arranged for and fully drawn on a $5.0 million credit facility collateralized by all of the Company’s investments, including its auction rate securities (see note 6 below).
Subsequent to September 30, 2008, we entered into an agreement with the investment bank that holds our auction rate securities, which gives the Company Auction Rate Securities Rights (Rights”) to sell all of our auction rate securities at par value back to the investment bank at any time during the period between June 30, 2010 and July 2, 2012 under the terms of a nontransferable rights offering. This agreement also gives the Company the right to borrow money from the investment bank in the form of a no net cost loan of up to 75% of the fair value of the auction rate securities. The Company is also exploring other alternatives under which it would liquidate its auction rate securities at par value, although it is not known when or to what extent such alternatives will be successful. Therefore we have reclassified our investments in auction rate securities from a Current Asset to a Non-Current Asset on our Consolidated Balance Sheet as of September 30, 2008.
Based on the Rights, we now have the ability, at a future date, to sell our auction rate securities at par value to the investment bank that holds our auction rate securities. Additionally, we intend to hold these securities until we can sell them at par value, either when the Rights are exercisable, or at an earlier opportunity to do so. Accordingly, the Company considers the decline in the estimated fair value of its investments in auction rate securities to be temporary. As such, we are reporting the decline in estimated fair value, which is considered to be temporary, of $0.4 million and $1.2 million for the three and nine month periods ended September 30, 2008, respectively, as Accumulated Other Comprehensive Income (Loss), a separate component of Shareholders’ Equity, as provided by Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of September 30, 2008, we did not own any derivative instruments, but we were exposed to market risks, primarily the impact of changes in United States interest rates on our short-term investments and on our short-term debt. As of September 30, 2008, we held total cash and cash equivalents of $5.4 million, available for sale securities of auction rate securities of $13.5 million and short-term debt of $5.0 million. All cash equivalents have a maturity less than 90 days. Declines in interest rates on our short-term investments over time would reduce our interest income from our investments. An increase in the interest rate on our short-term debt over time would increase our interest expense on our short-term debt. Based upon our cash and cash equivalents as of September 30, 2008, a decrease in interest rates of 1.0% would cause a corresponding decrease in our annual interest income on cash and cash equivalents of approximately $55,000. An increase in the interest rate of 1.0% on our short-term debt as of September 30, 2008 would cause a corresponding increase in our annual interest income of $50,000.
The market values of the available for sale securities may fluctuate due to market conditions and other conditions over which we have no control. Fluctuations in the market price and valuations of these securities may require us to record losses due to impairment in the value of the securities underlying the investment. This could result in future charges to our earnings. All of the auction rate securities held by the Company as of September 30, 2008 have experienced failed auctions. An auction failure is not a default. An auction failure means that the parties wishing to sell securities could not because the number of sellers was greater than the number of buyers of the reset dates. Refer to Note 4 of our financial statements for further discussion regarding the failed auctions of our available for sale securities in the auction markets as of September 30, 2008.
Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, including ensuring that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure. We necessarily apply judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives.
Our President and Chief Executive Officer/Acting Chief Financial Officer, has carried out an evaluation, with the participation of our management, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934), as of the end of the period covered by this report, based on the evaluation required by paragraph (b) of Rule 13a-15 under the Securities Act of 1934. Based upon such evaluation, our President and Chief Executive Officer/Acting Chief Financial Officer has concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There have been no significant changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2008, that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
NeoPharm, Inc. and certain of our former officers have been named in a consolidated amended complaint, which alleges various violations of the federal securities laws in connection with our public statements regarding our LEP drug product candidate during the period from October 31, 2001 through April 19, 2002. On November 4, 2002, we moved to have the complaint dismissed. Our motion to dismiss was granted in part and denied in part in February 2003. In November 2004, the plaintiffs filed a motion to amend and a motion for summary adjudication. The motion to amend sought to include certain pre-class period statements in the complaint. The motion for summary adjudication asked the Court to rule that certain statements made in an arbitration award regarding the LEP drug product candidate be deemed facts established in this proceeding. On February 23, 2007, the Court entered an order denying both the plaintiffs’ motion to amend and the plaintiffs’ motion for summary adjudication. Fact and expert discovery is closed. On March 21, 2008, the dispositive motion filing deadline, NeoPharm filed a motion for summary judgment, on which we are awaiting the court’s decision. No trial date has yet been set. We intend to vigorously defend each and every claim in the complaint. Management is unable to estimate the potential outcome or range of possibilities, if any. In addition, we maintain insurance coverage to mitigate the financial impact of any potential loss.
The employment of Mr. Guillermo Herrera, the former CEO of the Company, was terminated effective March 23, 2007. Since that date, he has retained counsel and on May 7, 2007, Mr. Herrera’s attorney filed a suit entitled Guillermo Herrera vs. NeoPharm, Inc., Case No. 2007 L 004711 in the Circuit Court of Cook County, Illinois, seeking payment of $212,500 for his 2006 bonus and $25,000 for a salary increase for 2007. Subsequent to the initiation of this action, the Company determined that under the terms of his employment agreement the Company should not be responsible for the payment of severance and terminated further payments. Mr. Herrera filed an Amended Complaint on February 21, 2008 alleging breach of his employment agreement with the Company, defamation, and tortuously presenting him in a false light. Mr. Herrera seeks an additional $363,612 representing the remaining severance payments, plus attorneys’ fees and costs. Mr. Herrera also seeks unspecified compensatory and punitive damages. The Company is vigorously defending this matter. We are unable at this time to make any prediction as to the outcome of this litigation.
Below are the risk factors that have been revised since the filing of our annual report on March, 28, 2008 on Form 10-K for the year ended December 31, 2007 (the “2007 Form 10-K”) and our Quarterly Reports on Form 10-Q for the Quarters ended March 31, 2008 and June 30, 2008 (“Prior 10-Qs”). We face significant additional risks, which are set forth in the Part I, Item 1A in our 2007 Form 10-K under the caption “Risk Factors.” You are urged to read these risk factors in the 2007 Form 10-K and Prior 10-Qs , in addition to the following revised risk factors set forth below. Each of the risk factors set forth here and in our 2007 Form 10-K and Prior 10-Qs could materially adversely affect our business, operating results and financial condition, as well as the value of an investment in our common stock. Additional risks and uncertainties not presently known to us, or those we currently deem immaterial, may also materially harm our business, operating results and financial condition.
Our investments could lose market value and consequently harm our ability to fund continuing operations.
Investments in both fixed-rate and floating-rate interest earning instruments carry varying degrees of interest rate risk. Fixed-rate securities may have their fair market value adversely impacted due to a rise in interest rates. In general, securities with longer maturities are subject to greater interest rate risk than those with shorter maturities. While floating-rate securities generally are subject to less interest rate risk than fixed-rate securities, floating-rate securities may produce less income than expected if interest rates decrease. Due in part to these factors, our investment income may fall short of expectations or we may suffer losses in principal if securities are sold that have declined in market value due to changes in interest rates.
We have invested a significant portion of our cash in auction rate securities, which subjects us to liquidity risk and could require us to record impairment charges if the fair value of these investments decline permanently or are other-than temporarily impaired. Furthermore, when we require additional cash resources, an absence of liquidity from these investments could require us to seek funds elsewhere, which may be more unattractive or unavailable, especially in light of the current instability of credit markets.
Investments in auction rate securities have scheduled maturities greater than 90 days at the time of purchase, and are classified as available-for-sale securities and recorded at fair value. Auction rate securities are used by many student-loan providers, municipalities and other governmental authorities to raise cash to fund projects or operations, and money market funds. These auction rate securities all have AAA/aaa credit ratings, consistent with our investment policy guidelines, and have long-term nominal maturities with provisions calling for the interest rates to be reset through periodic auctions every 7 to 28 days. This auction process has historically provided a liquid market for auction rate securities. In February 2008, all of the auction rate securities held by the Company as of September 30, 2008 have experienced failed auctions. An auction failure is not a default. An auction failure means that the parties wishing to sell securities could not because the number of sellers was greater than the number of buyers at the reset dates. The funds associated with failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, or the underlying securities have matured or are recalled by the issuer. We have entered into an agreement with the investment bank that holds our auction rate securities, which gives the Company Auction Rate Securities Rights (Rights”) to sell all of our auction rate securities at par value back to the investment bank at any time during the period between June 30, 2010 and July 2, 2012 under the terms of a nontransferable rights offering. This agreement also gives the Company the right to borrow money from the investment bank in the form of a no net cost loan of up to 75% of the fair value of the auction rate securities. The Company is also exploring other alternatives under which it would liquidate its auction rate securities at par value, although it is not known when or to what extent such alternatives will be successful. Accordingly, as of September 30, 2008, we are reporting our investments in auction rate securities as a long-term asset in our Consolidated Balance Sheet at their estimated fair value. Based on the Rights, we now have the ability, at a future date, to sell our auction rate securities at par value to the investment bank that holds our auction rate securities. Additionally, we intend to hold these securities until we can sell them at par value, either when the Rights are exercisable, or at an earlier opportunity to do so. Accordingly, the Company considers the decline in the estimated fair value of its investments in auction rate securities to be temporary. As such, we are reporting the decline in estimated fair value, which is considered to be temporary, of $0.4 million and $1.2 million for the three and nine month periods ended September 30, 2008, respectively, as Accumulated Other Comprehensive Income (Loss), a separate component of Shareholders’ Equity, as provided by Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities. If the fair value of these investments declines permanently or is other-than temporarily impaired, we would be required to take an impairment charge which would flow through our Condensed Consolidated Statement of Operations as an expense. Given the substantial dislocation in the financial markets and among financial services companies, we cannot be assured that the investment bank ultimately will have the ability to repurchase our auction rate securities at par, or at any other price, as these rights will be an unsecured contractual obligation of the investment bank or that if the investment bank determines to purchase our auction rate securities at any time, we will be able to reinvest the cash proceeds of any such sale at the same interest rate or dividend yield currently being paid to us. Also, as a condition of accepting the auction rate securities rights, we were required to sign a release of claims against the investment bank, which will prevent us from making claims against the investment bank related to our investment in auction rate securities, other than claims for consequential damages.
| The Nasdaq Capital Market may cease to list our common stock, which may cause our stock price to suffer and adversely affect the market liquidity of our common stock. |
On December 26, 2007, we received notice from the Nasdaq Stock Market (“Nasdaq”) advising us that for 30 consecutive trading days, the bid price of our common stock had closed below the minimum $1.00 per share requirement for continued listing under Nasdaq Marketplace Rule 4450(a)(5) (the “Rule”). The Company had until June 23, 2008 to regain compliance with the Rule. On June 24, 2008, Nasdaq notified the Company that as a result of the Company’s failure to comply with the Rule as of June 23, 2008, the Company’s common stock would be delisted unless the Company requested a hearing before a Nasdaq Listing Qualifications Panel, which the Company did on July 1, 2008. On August 14, 2008, the Company presented its plan to regain compliance with the Rule to the Panel. On September 4, 2008, the Company issued a press release announcing that it had received notification from the Panel granting the Company’s request to remain listed on The NASDAQ Stock Market, subject to the condition that, on or before December 22, 2008, the Company must evidence a closing bid price of $1.00 or more for a minimum of ten consecutive business days.
On October 21, 2008, the Company received notification from the Panel informing the Company that the Panel has extended the deadline for NeoPharm to regain compliance with NASDAQ’s minimum bid price requirement to March 27, 2009 from December 22, 2008. This extension was granted in accordance with NASDAQ’s decision to temporarily suspend for all companies currently listed on any NASDAQ market, the bid price and market value requirements for continued listing on such NASDAQ markets, given the recent extraordinary market conditions. As a result, the Company’s common stock will continue to be listed on The NASDAQ Capital Market, subject to the condition that, on or before March 27, 2009, the Company’s common stock must evidence a closing bid price of $1.00 or more for a minimum of ten consecutive business days.
Should the Company be unable to meet the conditions established by the Panel, its securities would be subject to delisting from The NASDAQ Stock Market. If our common stock were to be delisted, the delisting could adversely affect the market liquidity of our common stock and the market price of our common stock could decrease. Such a delisting could also adversely affect our ability to obtain financing for the continuation of our operations and could result in a loss of confidence by investors, suppliers and employees. In addition, our stockholders ability to trade or obtain quotations on our shares could be severely limited because of lower trading volumes and transaction delays. These factors could contribute to lower prices and larger spreads in the bid and ask price for our common stock.
| UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None
| DEFAULTS UPON SENIOR SECURITIES |
None
| SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS |
| On August 22, 2008, the Company held its Annual Meeting of Stockholders to vote on the matters listed |
| listed below. All of the matters voted on at the Annual Meeting were approved by the Company’s stockholders |
| at the Annual Meeting. | | | | | | | |
| | | | | | | | | |
| 1. To elect five directors to serve until the 2009 Annual Meeting of Stockholders. |
| With respect to the election for directors, the votes were as follows: |
| | | | | | |
| | Votes For | | Votes Against | | Votes Withheld | | |
| Frank C. Becker | 21,184,248 | | — | | 3,318,315 | | |
| Laurence P. Birch | 21,293,566 | | — | | 3,209,007 | | |
| Bernard A. Fox | | 21,319,886 | | — | | 3,182,677 | | |
| Paul E. Freiman | 17,158,806 | | — | | 7,343,757 | | |
| John N. Kapoor | 21,328,998 | | — | | 3,173,565 | | |
| | | | | | | | | |
2. To approve an amendment to the NeoPharm, Inc. 2006 Equity Incentive Plan to increase the maximum |
| number of shares of common stock that may be awarded under the Plan as restricted stock or as |
| bonus stock from 500,000 to 1,500,000. | | | |
| | | | | | | | | |
| | | | | | | | |
| Votes For | | Votes Against | | Abstain | | Non Votes | | |
| 11,564,502 | | 2,870,176 | | 25,457 | | 10,042,428 | | |
| | | | | | | | | |
3. To ratify the appointment of BDO Seidman, LLP as the Company's independent registered public |
| accountants for 2008. | | | | | | |
| | | | | | | | | |
| | | | | | | |
| Votes For | | Votes Against | | Abstain | | Non Votes | | |
| 23,884,890 | | 573,216 | | 44,457 | | 0 | | |
| | | | | | | | | |
Subsequent to September 30, 2008, we entered into an agreement with the investment bank that holds our auction rate securities, which gives the Company Auction Rate Securities Rights (Rights”) to sell all of our auction rate securities at par value back to the investment bank at any time during the period between June 30, 2010 and July 2, 2012 under the terms of a nontransferable rights offering. This agreement also gives the Company the right to borrow money from the investment bank in the form of a no net cost loan of up to 75% of the fair value of the auction rate securities. The Company is also exploring other alternatives under which it would liquidate its auction rate securities at par value, although it is not known when or to what extent such alternatives will be available. Accordingly, we have reclassified our investments in auction rate securities from a Current Asset to a Non-Current Asset on our Consolidated Balance Sheet as of September 30, 2008.
| 31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
| 32.1 | Certification pursuant to section 906 of the Sarbanes-Oxley Act or 2002 |
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.
| | | | |
| | /s/ Laurence P. Birch | |
| | | Laurence P. Birch | |
| | | President and Chief Executive Officer (Principal Executive Officer) and Acting Chief Financial Officer (Principal Financial Officer) | |
| | | | |
