Quarterly Update Report

Rating: Strong Buy

Basis for Rating

• The decline in NTI's stock this week, on the news that U.S. commercialization partner Forest Laboratories is voluntarily withdrawing the NDA filed on July 31, provides an excellent buying opportunity. Forest's rationale is sound, and we believe, could lead to a wider approval for Memantine in the U.S. than might have occurred under the July 31 NDA filing.
  
  
• NTI recently announced fourth quarter and year-end results for FY2002. Results were generally in line, but some higher-than-expected operational costs were incurred due to Xerecept clinical activities and one-time fees related to a terminated corporate transaction.
  
  
• In August, Memantine was officially launched in Europe by NTI's European partners, Merz & Co. GmBH and H. Lundbeck A/S under the trade names, Axura and Ebixa, respectively. Country-specific pricing approvals are proceeding and sales should begin to ramp during this and next calendar quarters.
  
  
• The Company's finances remain strong, finishing the fiscal year with over $7.2 million in cash and equivalents. The Company is maintaining a modest burn rate of about $4 million per year. Following the close of the fiscal year, NTI received a $1.4 million milestone payment from Merz for the marketing launch of Memantine for the treatment of moderate-to-severe Alzheimer's disease. NTI is likely to receive several additional milestone payments during the course of fiscal 2003 as Memantine begins to generate European sales and meets clinical and regulatory benchmarks here in the US.

Recent News

After what appeared to be a "win-win" announcement on September 12, concerning very favorable results of Forest Laboratories' pivotal trial of Memantine in combination therapy with donepezil (Pfizer's Aricept, an acetylcholinesterase inhibitor), investors all but threw in the towel when Forest announced earlier this week that it was voluntarily withdrawing the July 31 NDA filing. NTI stock declined over 15% on the news, which is typical of the effect of such announcements. Adding to the confusion were comments in Forest Laboratories' statement concerning the need to "correct certain structural and formatting deficiencies identified by the FDA". We believe that some investors threw the baby out with the bathwater, and have failed to grasp the nature of the strategic move on Forest's part.

By updating the filing with the inclusion of the donepezil combination pivotal study data, Forest improves the likelihood of a favorable FDA ruling, because this data includes US patients and meets the standard endpoints for Alzheimer's medications, which the European data submitted with the July 31 filing did not. In addition, with the combination data conveying strong results, Memantine potentially could be approved for more than the single indication of the intitial filing, thus expanding the market and perhaps setting the stage for follow-on approval in mild-to-moderate disease. Continued statistical support of early data suggesting Memantine improves cognition and daily functioning in Alzheimer's patients may be particularly instrumental in follow-on approvals.

The re-filing and submission of the complete analysis of the donepezil/Memantine data is expected to be completed by the end of the year 2002, and will include safety and efficacy data for Memantine as both a monotherapy and as a combination therapy with donepezil. We expect considerable interest in the combination therapy approach, as the two drugs work by entirely different mechanisms of action. The combinaton therapy may afford patients unique synergistic effects not seen when either medication is prescribed on its own.

Memantine for Diabetic Neuropathy
Memantine for indication in diabetic neuropathy continues to track on plan. The ongoing pivotal study being conducted by Forest Laboratories is running according to schedule. The final patient was dosed in August and the six month follow-up should be completed in early 2003. An early "cut" of the data may be available during the spring of 2003, with a NDA filing expected later in the year. NTI expects that Forest will be able to introduce Memantine for the diabetic neuropathy indication in 2004. Forest remains very optimistic about this indication for Memantine, and we expect will continue to move as quickly down the clinical and regulatory process as possible. While Memantine may not prove a panacea for this indication, like many pain medications, "beauty is in the eye of the beholder". We believe a great number of patients who do not get pain relief from current therapies may benefit from Memantine's different mechanism of action. We expect Forest will continue to give periodic updates on Memantine's progress in this indication.

Xerecept
During the latter part of fiscal 2002, NTI moved ahead on the development of Xerecept, its corticotropin releasing factor compound for peritumoral brain swelling. The FDA has granted NTI Orphan Drug Status for Xerecept in this indication. After some difficulties with a very short-term protocal for Xerecept in earlier clinical trials, NTI is now moving ahead with an eight-week study. Two new three-month toxicology studies will be completed during the latter part of 2002, and the Company expects to begin patient enrollment for the expanded trial around the New Year. The 140 patient study will be conducted at 10 centers around the U.S.

Financial Highlights

NTI reported its FY2002 results on September 27. As expected, the Company reported no revenues for the year as the recently announced milestone payment fell into FY2003. Operating expenses for the year rose to $4.6 million from $3.75 million in FY2001, reflecting additional costs from the Xerecept clinical program and one-time investment banking fees related to a terminated corporate transaction. The net loss for FY2002 was reported as $4.27 million, or $0.24 per share, compared to net income of $1.58 million, or $0.10 per share, in FY2001. During fiscal year 2001, NTI received its share of payments as a result of the Merz, Lundbeck, and Forest Laboratories marketing agreements. Our estimates called for a net loss of $0.19 per share. The primary reason for the differential between our estimate and reported results were higher-than-estimated Xerecept R&D costs incurred in the fourth quarter.

Research and development expenses rose to $2.01 million in fiscal 2002 compared to $1.19 million incurred in fiscal 2001. Most of the increase occurred during the fourth quarter when NTI manufactured a new supply of Xerecept for toxicology studies and for the upcoming expanded Xerecept clinical trials. General and administrative costs rose to $2.67 million compared to $2.56 million in fiscal 2001.

Looking ahead, we are maintaining our forecast of $3.3 million in revenue for fiscal 2003, which includes royalties on European sales of Memantine for the first time in the Company's history. We have made conservative assumptions as to the timing of milestone payments, and have fine-tuned our estimate of the loss for the year to $0.03 from our prior $0.02 per share. With Forest Laboratories operating on a calendar year and NTI on a fiscal year, there is some "play" possible in terms of revenue timing. Approximately $5.4 million in milestone payments related to Memantine are expected over the next 12-15 months.

We are now initiating a preliminary estimate for fiscal year 2004, and are looking for revenue of $5.8 million and net income of $0.09 per share. Again, the timing of milestone payments could substantially impact the year's revenue. Our 2004 forecast includes a conservative $2.4 million in product sales royalties. We expect to review this number as milestone timing issues warrant.

Discussion and Outlook

We expect that the resubmission of the Memantine filing by Forest Laboratories will be accepted by the FDA. We concur with those who believe that the combination therapy data, which fits FDA requirements for pivotal Alzheimer's study endpoints, is a much stronger package than the mixed population European data submitted with the July 31 data. In this regard, Forest Laboratories may be very shrewd, as Memantine will now be presented to the FDA as both a stand-alone medication and a combination therapy, thus expanding the product's overall potential patient base. The cognitive improvement shown in the combo therapy is unique among clinical results for Alzheimer's medications, and if the early cut of the data holds through the entire patient base, it could provide a significant motivation for approval. There are currently no approved Alzheimer treatments for moderate to severe disease, much less one that demonstrates an improvement in cognitive function as opposed to simply slowing the progression of the disease.

NTI management continues to move the Company down a prescribed, conservative path to profitability. While the Company approaches the threshold of generating product revenue and earnings, management continues to seek ways in which to enhance shareholder value. To that end, the Company will from time to time review a variety of potential corporate transactions which may bring in additional late stage CNS products to pipeline and add value. As many biotech companies suffer from severely restricted financing options in the current market, merging with, or an acquisition by, NTI could be particularly attractive as NTI maintains a consistently low burn rate and may in fact become profitable in a year's time. We believe NTI is an excellent candidate for investors interested in companies developing products to meet large medical needs but seeking a little less risk than the standard biotech development company. At its current level, we rate the stock a Strong Buy.

Company Brief

Neurobiological Technologies, Inc. is a drug discovery company focused on treatments for degenerative neurological disease and disorders. The Company develops neuroprotective and neuromodulatory pharmaceutical agents which treat the progressive neurological impairments characteristic of dementia, Alzheimer's disease, chronic diabetic neuropathy and brain cancer. The Company's lead product, Memantine, being commercialized for the US market with German partner, Merz & Co. Pharma GmbH, is the first of a second generation of neuroprotective agents whose mode of action relies on the N-methyl-D-asparate (NMDA) receptor pathway. Memantine has received an "approvable" classification by the EU regulatory authorities for the treatment of moderate to severe Alzheimer's disease and is progressing towards a US NDA. Clinical evidence strongly suggests certain second-generation NMDA pathway modulators may have signficantly better side effect profiles, better efficacy over long-term use and better neuroprotective characteristics than either first-generation products or acetocholinase (ACH) inhibitors.

The Company's scientific focus is on the prevention or amelioration of neuronal injury associated with a variety of acute, chronic and degenerative neurological conditions. Damaged neurons contribute significantly to functional impairment in many peripheral and central nervous system disorders, including chronic diseases such as diabetes, AIDS, and Alzheimer's disease. NTI is developing potential neuroprotective drugs to inhibit important pathways that lead to nerve cell damage, including calcium influx caused by glutamate leak (excitotoxicity) and cerebral edema (swelling of the brain).

Analyst:
Sherry Grisewood, CFA
Ms. Sherry Grisewood, CFA, has had extensive experience as a sell-side analyst, primarily in small cap stocks, and has worked for such firms as DLJ and EF Hutton. She has over 16 years experience as an independent special situations and small cap analyst, and has written a cash and futures market commentary since 1982. She has performed extensive analysis for investment banking projects and currently has her own practice working on securities analysis. Ms. Grisewood holds a B.S. degree with Highest Honors from Ramapo College of New Jersey and is a member of The New York Society of Security Analysts.

Contact:
Neurobiological Technologies, Inc. 3260 Blume Drive, Suite 500, Richmond, CA 94806. Phone: (510) 262-1730. Contact: Paul Freiman, CEO. Web site: www.ntii.com

J.M.Dutton & Associates, LLC. John M. Dutton, President and Supervisory Analyst, 1129 Manning Drive, Suite 310, El Dorado Hills, CA 95762 Phone (916) 941-4985, Fax (978) 418-6422 Email: [email protected] Web site: www.JMDutton.com

Information, opinions or recommendations contained in this research report are submitted solely for advisory and information purposes. The information used and statements of fact made have been obtained from sources considered reliable but we neither guarantee nor represent the completeness or accuracy. Such information and the opinions expressed are subject to change without notice. This research note is not intended as an offering or a solicitation of an offer to buy or sell the securities mentioned or discussed. Neither the Firm, its principals, nor the assigned analysts own or trade shares of any company covered. The Firm does not accept any equity compensation. Anyone may enroll a company for research coverage, which costs US $25,000 prepaid for one-year. Reports are performed on behalf of the public, and are not a service to any company. The analysts are responsible only to the public, and are paid in advance to eliminate pecuniary interests and insure independence. Please read full disclosure and other reports and notes on the Company at www.JMDutton.com.

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