NEOPHARM INC - 10-K Annual Report

FORWARD LOOKING STATEMENTS

This annual report on Form 10-K includes forward looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. We have based these forward looking statements largely on our current expectations and projections about future events and financial trends affecting the financial condition of our business. These forward looking statements are subject to a number of risks, uncertainties and assumptions about us, including, among other things:

· failure to achieve positive results in clinical trials;

· competitive factors;

· general economic conditions;

· the ability to attract and retain qualified management;

· available financial resources and inability to secure adequate funding for development projects;

· relationships with pharmaceutical and biotechnology companies;

· the ability to develop safe and efficacious drugs;

· variability of royalty, license and other revenue;

· uncertainty regarding the outcome of current legal proceedings;

· failure to satisfy performance obligations in our licenses or other contracts;

· ability to enter into future collaborative agreements;

· uncertainty regarding our patents and patent rights (including the risk that we may be forced to engage in costly litigation to protect such patent rights and the material harm to us if there were an unfavorable outcome of any such litigation);

· governmental regulation;

· technological change;

· changes in industry practices; and

· one-time events.

In addition, in this annual report, the words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions, as they relate to us, our business, or our management, are intended to identify forward looking statements. All of our forward looking statements are qualified in their entirety by reference to the factors discussed in this document under the heading ITEM 1.—“BUSINESS—RISK FACTORS,” and any documents incorporated by reference that describe risks and factors that could cause results to differ materially from those projected in these forward looking statements.

We caution you that the risk factors contained herein are not exhaustive. We operate in a continually changing business climate and we do not intend to publicly update or revise any forward looking statements, whether as a result of new information, future events, or otherwise, after the date of this annual report. In light of these risks and uncertainties, the forward looking events and circumstances discussed in this annual report may not occur and actual results could differ materially from those

anticipated or implied in the forward looking statements. Accordingly, you should not rely on forward looking statements as a prediction of actual results.

BUSINESS OVERVIEW

NeoPharm, Inc. is a Delaware corporation incorporated on June 15, 1990 under the name of OncoMed, Inc. In March 1995, we changed our name to NeoPharm, Inc. During 2004, we established a wholly-owned subsidiary, NeoPharm EU Limited, in order to comply with regulatory requirements enacted by the European Union for clinical trials conducted in member countries.

We are a biopharmaceutical company engaged in the research, development, and commercialization of drugs for the treatment of cancer. We have built our drug portfolio based on two proprietary technology platforms: the NeoLipid liposomal drug delivery system and a tumor-targeting toxin platform. We have four drug product candidates in various stages of clinical development for the treatment of cancer. The following table summarizes key information about our current drug product candidate pipeline:

Drug product candidate	Clinical indication(s)	Clinical development status	Commercialization rights
Cintredekin besudotox
(IL13-PE38QQR)	Glioblastoma multiforme (brain cancer)	Phase III	Worldwide(1)
LE-SN38	Colorectal cancer and other solid tumors	Phase II(2)	Worldwide
LEP-ETU	Breast cancer, lung cancer, ovarian cancer, and other solid tumors	Phase I	Worldwide
LErafAON	Cancer	Phase I	Worldwide

(1) Development and commercialization rights for Japan have been sublicensed to Nippon Kayaku Co., Ltd.

(2) Phase I clinical trial completed in 2004. Phase II expected to start in 2005.

Our most advanced drug product candidate is cintredekin besudotox, a tumor-targeting toxin being developed as a treatment for glioblastoma multiforme, a deadly form of brain cancer. Based on the results from our Phase I/II clinical trials, we began a Phase III clinical trial (the “PRECISE” trial) in the first quarter of 2004. We currently estimate that patient enrollment for the PRECISE trial should be completed in 2005.

In addition, three compounds based on our NeoLipid drug delivery platform are currently in Phase I or Phase II clinical development. These compounds are:

· LE-SN38, a liposomal formulation of SN-38, the active metabolite of the pro-drug irinotecan (marketed in the U.S. as Camptosar® by Pfizer), which is currently approved by the U.S. Food and Drug Administration (FDA) for the treatment of colorectal cancer;

· LEP-ETU, a liposomal formulation of the anti-cancer agent paclitaxel (marketed in the U.S. as Taxol® by Bristol-Myers Squibb), which is currently approved by the FDA for the treatment of breast, lung, and ovarian cancer; and

· LErafAON, our liposomal antisense oligonucleotide under development as a therapeutic enhancement for both radiation therapy and cancer chemotherapy.

NeoLipid technology combines drugs or other compounds with our proprietary lipids and allows for the creation of a stable liposome. This physical property is especially important during drug storage and

after the drug has been administered intravenously to the patient. We believe our NeoLipid technology may have applications in a variety of other areas in addition to our drug product candidates in clinical development. We have developed a new transfection agent, NeoPhectin™, which we began providing to research laboratories in January 2004. Furthermore, we are exploring ways to leverage our NeoLipid technology to develop therapeutic formulations of small molecules and biologic molecules such as RNAi, and we are currently conducting and planning research to investigate potential drug product candidates that can make use of this technology.

In January 2004, we completed the sale of 4,312,500 shares of our common stock to the public. Proceeds to the Company were approximately $73.5 million net of underwriting fees and expenses. The proceeds from this sale of stock are being used to fund clinical trials of our drug product candidates; preclinical studies for other potential drug product candidates; and for working capital, capital expenditures and other general corporate purposes.

MARKET OVERVIEW

According to the American Cancer Society (ACS) 2005 Cancer Facts and Figures, cancer is the second leading cause of death in the United States, accounting for one in every four deaths. The ACS 2005 Cancer Facts and Figures also estimates that doctors will diagnose over 1.3 million new cases of cancer in the United States in 2005. The National Institutes of Health (NIH) estimate that the annual cost of cancer in 2004 was approximately $189.8 billion, including $69.4 billion in direct medical costs and $16.9 billion for morbidity costs, which includes the cost of lost productivity.

Cancer is characterized by uncontrolled cell division resulting in the growth of a mass of cells commonly known as a tumor. Cancerous tumors can arise in almost any tissue or organ and cancer cells, if not eradicated, spread, or metastasize, throughout the body. Cancer is believed to occur as a result of a number of factors, including hereditary and environmental factors.

For the most part, cancer treatment depends on the type of cancer and the stage of disease progression. Generally, staging is based on the size of the tumor and whether the cancer has metastasized. Following diagnosis, solid tumors are typically surgically removed or the patient is given radiation therapy. Chemotherapy is the principal treatment for tumors that are likely to, or have, metastasized. Chemotherapy involves the administration of cytotoxic drugs, which are designed to kill cancer cells, or administration of hormones, which affect the growth of tumors.

Because in most cases cancer is fatal, cancer specialists attempt to attack the cancer aggressively, with as many therapies as available and with as high a dose as the patient can tolerate. Since chemotherapy attacks both normal and cancerous cells, treatment often tends to result in complicating side effects. Additionally, cells which have been exposed to several rounds of chemotherapy develop a resistance to the cancer drugs that are being administered. This is known as “multi-drug resistance”. The side effects of chemotherapy often limit the effectiveness of treatment. Cancers often recur and mortality rates remain high. Despite large sums of money spent on cancer research, current treatments are inadequate and improved anti-cancer agents are needed.

The products we currently have under development target a broad range of solid tumors. The table below shows the incidence and mortality estimated for the year 2005 for various types of solid tumor cancers that our products seek to treat:

Cancer Indication	New Cases	Deaths
Breast	212,930	40,870
Lung	172,570	163,510
Colorectal	145,290	56,290
Ovarian	22,220	16,210
Brain	18,500	12,760

Source: American Cancer Society, 2005 Cancer Facts and Figures

BUSINESS STRATEGY

Our goal is to become a leading biopharmaceutical company focused on discovering, developing, and commercializing innovative anti-cancer treatments. Our strategy consists of the following key elements:

Focus on the growing cancer market

Cancer is the second leading cause of death in the US, yet there remain unmet needs, and current treatments remain ineffective and inadequate for some populations. Given the life-threatening nature of cancer, the FDA has adopted procedures to accelerate the approval of cancer drugs. We intend to continue to use our expertise in the field of cancer research to target this significant market opportunity for cancer drug development.

Develop our existing product portfolio

We currently have a portfolio of four anti-cancer drug product candidates which have advanced to clinical trials and are under development. We intend to further develop these products both by expanding our internal resources and by continuing to collaborate with other companies and leading governmental and educational institutions.

Create new products by capitalizing on our NeoLipid platform

We intend to further explore the use of our proprietary NeoLipid liposomal technology to create new products in two ways: by extending the patent life 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. We are working to extend the marketing exclusivity for paclitaxel through our LEP-ETU compound. While many chemotherapeutic drugs such as paclitaxel 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. Using our NeoLipid technology, we believe opportunities exist for us to increase the usefulness of these compounds as improved anti-cancer treatments. In addition, we believe that our liposomal technology may provide us with a platform for the development of novel therapeutic agents for cancer drug development.

Increase the potential for commercial success through diversification

We are developing several drug product candidates simultaneously in an attempt to increase our chances of commercial success through diversification. In addition, by broadening our drug product candidate portfolio, we increase our flexibility to eliminate drug product candidates that we determine may

have less market potential while applying additional resources to the drug product candidates that show promise.

Commercialize pharmaceutical products focused on cancer in selected markets

Our goal is to bring to market novel drugs that address significant unmet needs in cancer treatment. In North America, we may develop a specialized cancer sales and marketing capability or work with third parties to market our future products to specialty physicians. As appropriate, we may establish collaborations with multinational pharmaceutical companies to assist in the commercialization of our drug product candidates outside of North America.

DRUG PRODUCT CANDIDATES

Cintredekin besudotox (IL13-PE38QQR)

We have initiated a pivotal Phase III clinical trial, which we refer to as the PRECISE trial, for cintredekin besudotox for the treatment of glioblastoma multiforme, 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 (CRADA) with the FDA Center for Biologics Evaluation and Research (CBER). Cintredekin besudotox has received orphan drug designation in the US and Europe and fast track drug development program status from the FDA. In addition, cintredekin besudotox has been selected to participate in the FDA’s Continuous Marketing Application (CMA) Pilot 2 program.

To qualify for orphan drug designation, a proposed compound must be intended for use in the treatment of a condition that affects fewer than 200,000 people in the United States. The fast track program of the FDA is designed to facilitate the development and expedite the review of new drugs that are showing positive progress in treating serious or life-threatening conditions and that demonstrate the potential to address unmet medical needs. The CMA Pilot 2 program was designed to evaluate the cost of enhanced interaction between the FDA and applicants and whether it improves the efficiency and effectiveness of development programs, and is limited to no more than one Fast Track product for each of 20 participating FDA review divisions.

Conventional, non-specific chemotherapeutic drugs attack abnormal 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, on the other hand, 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, an immune regulatory cytokine (IL-13). Malignant glioma cells, as compared to normal brain cells, express IL-13 receptors at a higher density. IL-13 is an immune regulatory cytokine, or protein, secreted by cells. 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 cancer cells and selectively deliver PE38 to destroy tumor cells while sparing healthy surrounding 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 the tumor or brain tissue surrounding the tumor before and/or 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.

Preliminary Phase I/II data published from the four studies of cintredekin besudotox conducted to date represent clinical data from nearly 100 patients in various clinical settings, including intra and peritumoral delivery of cintredekin besudotox for treatment of malignant glioma. The findings suggest possible evidence of tumor cytotoxic (cancer cell killing) effects of cintredekin besudotox against malignant glioma tumor cells. Although these studies were not designed to address efficacy, encouraging survival results continue to be observed beyond two years following treatment, in some patients.

Based on the data from these studies, we began the PRECISE trial in the first quarter of 2004. This trial is designated to be a multi-center, multi-national study enrolling approximately 300 patients suffering from first recurrent glioblastoma multiforme tumors who will be randomized into one of two treatment arms of the study. One group, approximately 200 patients, will receive convection-enhanced infusion of cintredekin besudotox after surgery and the other group, approximately 100 patients, will be treated through placement of Gliadel® Wafers (Guilford Pharmaceuticals) at the time of surgery. Gliadel Wafers are approved for treatment of patients undergoing initial surgery for and after recurrence of the disease. The primary end point of the study is to determine if there is a statistically significant overall patient survival difference between the two arms of this study.

Additionally, we initiated a Phase I clinical trial of cintredekin besudotox during the third quarter of 2004 that is designed to test the safety and tolerability of cintredekin besudotox in malignant glioma patients at initial diagnosis. Malignant gliomas are a type of brain tumor that includes glioblastoma multiforme, anaplastic astrocytoma, and malignant mixed oligoastrocytoma, among others. The Phase I clinical trial is being conducted in collaboration with the American College of Surgery Oncology Group (ACOSOG), and is expected to complete enrollment in 2005.

LE-SN38

LE-SN38 is our NeoLipid liposomal formulation of SN-38, the active metabolite of Camptosar, 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 colorectal cancer cells 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. By employing our proprietary NeoLipid technology to deliver SN-38, we hope to deliver the active drug to the tumor cells without the need for conversion and with fewer side effects. Other tumor cells convert Camptosar less efficiently than colorectal cancer cells, and consequently Camptosar is currently approved only for the treatment of colorectal cancer. Since LE-SN38 does not depend on the conversion process, it may have potential as a treatment for other types of cancer such as breast, lung, prostate and pancreatic cancer.

During 2004, we completed a Phase I clinical trial for LE-SN38. The primary objectives of the Phase I study were to determine the pharmacogenomics, pharmacokinetics, and safety of LE-SN38 in patients with advanced local or metastatic solid tumors who have failed conventional therapy. Tumor progression was also monitored. In this trial, groups of patients received escalating doses of intravenous LE-SN38 infusion over 90 minutes every 21 days until disease progression or unacceptable toxicity levels were reached. Results from this Phase I study demonstrated the safety and tolerability of LE-SN38 and established a maximum tolerated dose (MTD) for all but a small subset of patients that 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. In addition, dose limiting diarrhea was not

observed. We are currently planning to initiate a Phase II clinical trial in colorectal cancer patients during 2005 in collaboration with the Cancer and Leukemia Group B (CALGB) cooperative study group.

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. We believe that by using our proprietary NeoLipid technology, which eliminates the need for Cremophor and ethanol, LEP-ETU may overcome many current limitations of paclitaxel treatment for cancer patients and may limit the adverse side effects of current treatments.

During 2004, we completed a Phase I clinical trial for LEP-ETU. Initial results, from 25 patients, indicated that LEP-ETU appeared to be well tolerated in terms of typical paclitaxel side effects by the majority of patients, including those receiving the higher doses of drug, as well as those who were not premedicated with antihistamines and steroids. Antitumor activity was observed, with three patients experiencing partial responses (shrinkage of tumor by 50% or more). Eleven other 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 responded to LEP-ETU.

LEP-ETU is currently in a clinical trial designed to assess whether LEP-ETU is bio-equivalent to Taxol. If results of this trial confirm that LEP-ETU has the same pharmacokinetic profile as Taxol, we would be able to take a potentially faster, less expensive, path to submit an application to the FDA for approval of the drug product candidate.

LErafAON

We are also developing a liposomal antisense drug, LErafAON. Antisense drugs are designed to work by interfering with gene expression of proteins involved in a disease. Antisense molecules are thought to have a great potential as therapeutics, but delivery of the antisense molecule to the cell has proven to be a significant obstacle to realizing this potential. Two techniques have been used to deliver antisense into cells: liposomal delivery and viral-vector delivery.

Viral delivery vehicles have not been widely adopted and used because they can cause irreversible genetic changes that can have long-term side effects, including possibly cancer, are difficult to establish, and may also cause an adverse immune response.

LErafAON utilizes our NeoLipid technology and is designed to interfere with the expression by tumor cells of a protein known as c-raf. This protein is expressed at higher levels in various tumors including breast, ovarian and prostate cancers. By inhibiting expression of the c-raf protein, LErafAON may have independent anti-tumor activity and may render tumor cells more susceptible to radiation or chemotherapy. Pre-clinical studies indicate that LErafAON may prove to be beneficial in enhancing the activity of a broad range of chemotherapies in the treatment of various forms of cancer. Our liposomes provide a non-viral method of delivering the antisense oligonucleotide into the cell via intravenous administration.

To date, we have completed two Phase I clinical trials using LErafAON. One study involved the use of LErafAON as a single agent in cancer patients with various solid tumors, and the second study involved the use of LErafAON in combination with radiation therapy in cancer patients with radiation resistant

tumors. During the fourth quarter of 2004, we initiated a Phase I clinical trial of LErafAON which now takes advantage of our new cationic cardiolipin based NeoPhectin™ technology. The primary endpoint of the Phase I study is to determine the dose limiting toxicity (DLT) and maximum tolerated dose (MTD) of LErafAON. The pharmacokinetics and tumor treatment effect of LErafAON will also be assessed. Patient enrollment is anticipated to be completed in 2005, but depends on the number of dose levels studied.

Competition

Each of the drug product candidates we currently have under development will face competition from products currently on the market or under development. The following table lists our current principal competitors and their products, which compete with the listed drug product candidates we currently have under development:

Our drug product candidate	Principal competitor	Competitor’s product
Cintredekin besudotox	Guilford Pharmaceuticals, Inc.	Gliadel® Wafer
LE-SN38	Pfizer Inc.	Camptosar®
LEP-ETU	Bristol-Myers Squibb Co.	Taxol®
LErafAON	Isis Pharmaceuticals Inc.	Antisense products(1)

(1) There are currently no antisense products available on the market for the treatment of cancer, but Isis Pharmaceuticals, Genta, and others are developing such products.

We also compete with drug development companies for licenses to novel technologies as well as for collaborations with large pharmaceutical and other companies.

OTHER PRODUCTS

In addition to development of our drug product candidates, our research efforts have yielded two new non-drug products that we have commercialized.

NeoPhectin™ and NeoPhectin-AT™

NeoPhectin is a novel in vitro transfection reagent based on our proprietary cationic (positively charged) cardiolipin liposome based technology. We designed NeoPhectin to enable researchers to transfect a variety of cell types in laboratory settings. We began providing NeoPhectin gene transfection kits to distributors of scientific research supplies in January 2004. NeoPhectin-AT is our in vivo transfection reagent designed for use in animal testing and was first made available to distributors in March 2004. NeoPhectin consists of small, stable homogeneous, ready-to-use liposomes that have shown less toxicity to cells and are able to transfect a variety of cell types.

We believe that cationic liposomes have significant market potential in DNA/RNA therapy if a successful system, such as NeoPhectin, were to be available. As an alternative to viral systems, cationic liposomes are the most commonly used systems for transfection. While cationic liposomes form spontaneous complexes with DNA or RNA, and have shown greater transfectio

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		Page
PART I
Item 1.	Business		1
Item 2.	Properties		31
Item 3.	Legal Proceedings		31
Item 4.	Submission of Matters to a Vote of Security Holders		32
PART II
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities		34
Item 6.	Selected Financial Data		35
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation		36
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		43
Item 8.	Financial Statements and Supplementary Data		43
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		43
Item 9A.	Controls and Procedures		43
Item 9B.	Other Information		44
PART III
Item 10.	Directors and Executive Officers of the Registrant		44
Item 11.	Executive Compensation		44
Item 12.	Security Ownership of Certain Beneficial Owners and Management		44
Item 13.	Certain Relationships and Related Transactions		44
Item 14.	Principal Accounting Fees and Services		45
PART IV
Item 15.	Exhibits, Financial Statement Schedules		45
	Signatures		50