**UNITED STATES**

**SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C.20549**

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**FORM 10-K**

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**ý****   ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe fiscal year ended December 31, 2004**

 

**Commission File No.0-16614**

 

**NEORX CORPORATION**

**(Exact name ofRegistrant as specified in its charter)**

 

| **Washington**                                                           | ** ** | **91-1261311**                         |
|--------------------------------------------------------------------------|------------|----------------------------------------|
| (State or other jurisdiction of incorporation or organization) |       | (IRS Employer Identification No.) |

**300 Elliott AvenueWest, Suite 500, Seattle, Washington 98119**

(Address ofprincipal executive offices)

Registrant’s telephone number, includingarea code: **(206) 281-7001**

Securitiesregistered pursuant to Section 12(b) of the Act:

**None**

Securitiesregistered pursuant to Section 12(g) of the Act:

**Common Stock, $.02Par Value**

**$2.4375 ConvertibleExchangeable Preferred Stock, Series 1**

 

Indicate by check mark whether theRegistrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

| Yes | ý | No | o |
|-----|--------|----|---|

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of Registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this Form 10-K.   ý

 

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

| Yes | ý | No | o |
|-----|--------|----|---|

 

The aggregate market value of the votingand non-voting common equity held by nonaffiliates of the Registrant wasapproximately $74.9 million as of June 30, 2004, based on a per share closingprice of $2.49 on the Nasdaq SmallCap Market on that date.  Shares of Common Stock held by each officer,director and holder of 5% or more of the outstanding Common Stock have beenexcluded in that such persons may be deemed to be affiliates. Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

As of March 17, 2005, 34,228,953 shares ofthe Registrant’s Common Stock, $.02 par value per share, were outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the Registrant’s ProxyStatement for the Registrant’s 2005 Annual Meeting of Shareholders, areincorporated by reference in Part III of this Form 10-K.

 

 

 

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## ** **

## **PARTI**

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## **IMPORTANT INFORMATION REGARDINGFORWARD-LOOKING STATEMENTS**

 

ThisForm 10-K contains forward-looking statements. These statements relate to future events or future financialperformance.  In some cases, you canidentify forward-looking statements by terminology such as “may,” “will,” “should,”“expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,”“propose” or “continue,” the negative of these terms or other terminology.  These statements reflect our current viewswith respect to future events and are based on assumptions and are subject torisks and uncertainties.  We discuss manyof these risks in greater detail under the heading “Risk Factors” below.  Given these uncertainties, you should notplace undue reliance on these forward-looking statements, which speak only asof the date of this report.

Youshould read this Form 10-K and the documents that we incorporate by referencecompletely and with the understanding that our actual results, performance andachievements may be materially different from any future results, performanceor achievements expressed or implied by the forward-looking statements.  We undertake no obligation to update publiclyany forward-looking statements to reflect new information, events or circumstancesafter the date of this report, or to reflect the occurrence of unanticipatedevents.

### **RISK FACTORS**

 

In addition to the otherinformation contained in this report, the following factors could affect ouractual results and could cause our actual results to differ materially fromthose achieved in the past or expressed or implied by our forward-lookingstatements.

**Risks Related to Our Business**

 

**We have a history of operating losses, we expectto continue to incur losses, and we may never become profitable.**

 

We have not beenprofitable since our formation in 1984. As of December 31, 2004, we had anaccumulated deficit of $234.3 million. Our net losses were $19.4 million forthe year ended December 31, 2004.  We hadnet losses of $5.1 million for the year ended December 31, 2003, and $23.1million for the year ended December 31, 2002. These losses resulted principallyfrom costs incurred in our research and development programs and from ourgeneral and administrative activities. To date, we have been engaged only inresearch and development activities and have not generated any significantrevenues from product sales. We do not anticipate that our proposed STRTM (bone-targetingradiotherapeutic) and NX 473 (platinum compound) product candidates, or any otherproposed products, will be commercially available for several years, if at all.We expect to incur additional operating losses in the future. These losses mayincrease significantly if we expand clinical development, manufacturing andcommercialization efforts.

 

Our ability to achievelong-term profitability is dependent upon obtaining regulatory approvals forour STR and NX 473 product candidates and any other proposed products andsuccessfully commercializing our products alone or with third parties.

 

**We will need to raise additional capital, and ourfuture access to capital is uncertain.**

 

It is expensive todevelop cancer therapy products and conduct clinical trials for these products.Total estimated costs to complete the STR Phase III clinical trial andpotentially obtain marketing approval are in the range of $35-40 million,including the cost of clinical drug supply. These costs could be substantiallyhigher if we have to repeat, revise or expand the scope of our trials, orconduct additional clinical trials not presently planned, to secure marketingapprovals. These estimated costs exceed our current capital resources, and wewill be required to obtain additional funding to continue development of STR,including the Phase III clinical trial, to initiate development of ournewly-acquired NX 473 platinum compound, to commercialize STR, NX 473 or anyother proposed products, and to fund ongoing operations.

 

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We raisedapproximately $3.9 million in net proceeds from the sale of common stock andwarrants in a private placement transaction on March 7, 2005.  We intend to use the net proceeds from thisfinancing added to our existing funds to support our Phase III trial in STR, toinitiate a Phase II trial in NX 473 in small cell lung cancer and for generalworking capital.  With the proceeds of thisoffering, we had total cash and marketable securities of $17.8 million at March7, 2005.

 

Our consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States, assuming that the Company will continue as a going concern.While management believes that current cash and cash equivalent balances, andany net cash provided by operations, may provide adequate resources to fundoperations at least until December 31, 2005, this may not be the case.  Management is therefore exploring a number ofalternatives to enable us to continue operating including:

 

•                    raisingadditional capital to fund continuing operations by private placements or othersales of equity or debt securities or through the establishment of otherfunding facilities;

 

•                    enteringinto strategic collaborations, which may include joint ventures or partnershipsfor product development and commercialization, merger, sale of assets or othersimilar transactions; and

 

•                    obtainingadditional capital resources to fund operations through cost cuttingmechanisms, including the delay, reduction or curtailment of our current andplanned STR and NX 473 development programs.

 

There can be no assurance that any of thesealternatives will be successful.  We maynot be able to obtain the required additional capital or enter intorelationships with corporate partners on a timely basis, on favorable terms, orat all.  Conditions in the capitalmarkets in general, and the life science capital market specifically, mayaffect our potential financing sources and opportunities for strategicpartnering. If we raise additional funds by issuing common stock or securitiesconvertible into or exercisable for common stock, further dilution toshareholders may result, and new investors could have rights superior tocurrent security holders.  If we areunable to obtain sufficient cash when needed to fund our operations, we may beforced to seek protection from creditors under the bankruptcy laws.

 

The amount of additional financing we require willdepend on a number of factors, including the following:

 

•               therate of progress and costs of our STR clinical trials and research anddevelopment activities, including our ability to activate clinical sites andenroll qualified patients into our STR Phase III clinical trial;

 

•               ourability to obtain clinical material from third-party suppliers and manufactureSTR in a timely and cost-effective manner;

 

•               actionstaken by the U.S. Food and Drug Administration (FDA) and other regulatoryauthorities;

 

•               thescope and timing of our proposed NX 473 clinical program and other research anddevelopment efforts;

 

•               theacquisition or in-licensing of other products or intellectual property, if wechoose to undertake such activities;

 

•               thecosts of discontinuing projects and technologies or decommissioning existingfacilities, if we undertake those activities;

 

•               thetiming and amount of any milestone or other payments we might receive fromexisting and potential strategic partners and licensees;

 

•               ourdegree of success in commercializing STR, NX 473 or any other cancer therapyproduct candidates;

 

•               theemergence of competing technologies and products, and other adverse marketdevelopments; and

 

•               thecosts of preparing, filing, prosecuting, maintaining and enforcing patentclaims and other intellectual property rights.

 

**Our potential products must undergo rigorousclinical testing and regulatory approvals, which could be costly, timeconsuming, and subject us to unanticipated delays or prevent us from marketingany products.**

 

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The manufacture and marketing of our proposed STR andNX 473 product candidates and our research and development activities aresubject to regulation for safety, efficacy and quality by the FDA in the UnitedStates and by comparable authorities in other countries.

 

The process of obtaining FDA and other requiredregulatory approvals, including foreign approvals, is expensive, often takesmany years and can vary substantially depending on the type, complexity andnovelty of the products involved. Our STR product candidate is novel; this maylengthen the regulatory review process, increase our development costs anddelay or prevent commercialization of such product candidate.

 

In October 2000, the FDA placed all of our clinicaltrials of STR on clinical hold because of a serious toxicity that developed inabout 10% of patients treated with STR on our Phase I/II trials in multiplemyeloma. This toxicity, which is called thrombotic thrombocytopenicpurpura/hemolytic uremic syndrome (TTP/HUS), emerged six to 13 monthsafter treatment. As a condition to lifting the clinical hold, the FDA requestedthat we collect additional data from a small number of multiple myelomapatients to validate the patient-specific dosing method we used in earlierstudies of STR and which we proposed to use in our planned pivotal trialprogram. In addition, the FDA asked us to undertake a dosimetry study to quantifythe exposure of certain organs, including the kidney, the bone and the bonemarrow, to radiation from STR. The dosimetry study also used an adjustedradiation dosage and a revised administration regimen. We submitted data fromour dosimetry study to the FDA in February 2003, along with a proposal forfurther clinical development of STR in patients with primary refractory myeloma(myeloma that has not been responsive to conventional first-line chemotherapy),using a revised dosing method. The FDA lifted the clinical hold inApril 2003.

 

TTP/HUS is a syndrome that sometimes occurs in patientsconditioned for bone marrow transplant with total body irradiation. It isbelieved to be caused, at least in part, by radiation injury to the kidneys. Ofthe seven patients who developed TTP/HUS believed to be related to treatmentwith STR, two were alive at last follow-up in 2004. Three patients died withdisease progression, making it difficult to determine the cause of death, andtwo patients died without disease progression, suggesting that TTP/HUS may havebeen a cause of death. Our studies indicated that the occurrence ofdrug-related TTP/HUS in the Phase I/II trials was dependent on the dose of STRadministered. The lowest dose at which drug-related TTP/HUS occurred was 938mCi/m2. In the Phase III trial, thedose of STR has been reduced to 750 mCi/m2. Nocases of drug-related TTP/HUS have been seen among the fifteen patients treatedin the Phase I/II studies at comparable doses of STR.

In October 2003, we reached agreement with the FDA on our STR PhaseIII clinical trial design. This agreement, called a Special ProtocolAssessment, establishes the number of patients to be studied and how and whenthe drug’s safety and effectiveness will be determined. At the same time, theFDA confirmed that a single Phase III trial is sufficient to obtain marketing approvalfor STR, provided that the drug is shown to be safe and effective in thetrial.  Under the Special ProtocolAssessment, the FDA has agreed to complete response to STR as the efficacyendpoint for the clinical trial, which is a surrogate endpoint for patientsurvival, and we havecommitted to follow the Phase III patients to monitor survival in a subsequent PhaseIV study. If we are successful in meeting the surrogate endpoint, but do notdemonstrate improved survival rates in our Phase IV study, the FDA may takeactions which delay or limit the use of our STR product and the commercialsuccess of such product may be significantly limited. The FDA may, at any time,revise the Phase III clinical trial and Phase IV study requirements under theSPA for a variety of reasons. Any change may materially affect our ability tocomplete the clinical trial on a timely and cost-effective basis, or at all.

 

We have had only limited experience in filing andpursuing applications necessary to gain regulatory approvals. This may impedeour ability to obtain timely approvals from the FDA or foreign regulatoryagencies. We will not be able to commercialize our product candidates until weobtain regulatory approval, and consequently any delay in obtaining, orinability to obtain, regulatory approval could harm our business.

 

If we violate regulatory requirements at any stage,whether before or after marketing approval is obtained, we may be fined, forcedto remove a product from the market or experience other adverse consequences,including delay, which could materially harm our financial results.Additionally, we may not 

 

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be able to obtain the labeling claims necessary or desirable forproduct promotion. In addition, if we or other parties identify serious sideeffects after any of our products are on the market, or if manufacturingproblems occur, regulatory approval may be withdrawn and reformulation of ourproducts, additional clinical trials, changes in labeling of our products,and/or additional marketing applications may be required.

 

The requirements governing the conduct of clinicaltrials and manufacturing and marketing of our proposed products outside theUnited States vary widely from country to country. Foreign approvals may takelonger to obtain than FDA approvals and can involve additional testing. Foreignregulatory approval processes include all of the risks associated with the FDAapproval processes. Also, approval of a product by the FDA does not ensure approvalof the same product by the health authorities of other countries.

 

**We may take longer to complete our clinical trialsthan we project, or we may be unable to complete them at all.**

 

We opened a Phase IIItrial of STR to patient enrollment in March 2004 and plan to conduct the trialat multiple sites in the US and Canada. The actual time to completion of ourSTR Phase III clinical trial will depend upon numerous factors, including our abilityto open clinical sites and enroll qualified patients into our trial, our abilityto obtain additional capital to fund the trial, our ability to manufacture theSTR compound and distribute it to the clinical sites on a timely basis, and actionsby the clinical institutions, the FDA and other regulatory agencies. There arepresently 20 clinical sites open and we plan to have as many as 40 clinicalsites participating in the trial. Initial patient accrual in our Phase III trial has progressed moreslowly than expected. There are a very limited number of patients with primaryrefractory myeloma who will be qualified for enrollment in our Phase IIIclinical trial, and that number may become more limited if emerging therapiesare more effective than existing therapies. We have undertaken a number ofmeasures, including a substantial patient and community oncologist outreachprogram, designed to make referring physicians and patients more aware of STRand the Phase III trial. We also are working with the FDA to amend theeligibility criteria for our trial as a means of potentially increasingenrollment. We may not be able to enroll enough qualified patients to completethe clinical trial in a timely manner, or at all. We do not plan to announcethe opening of clinical sites or the enrollment of patients.  We anticipate that the STR Phase III trialwill take several years to complete, and we do not expect to submit a New DrugApplication (NDA) for the potential approval of STR to the FDA before 2008. Ifour enrollment outreach efforts are not successful or other factors outlinedabove adversely affect our efforts, the date of our submission of an NDA forthe potential approval of STR by the FDA could be substantially delayed.

 

In October 2004, we filed an investigational new drugapplication (IND) with the FDA for a Phase II clinical trial of NX 473 for thetreatment of patients with small cell lung cancer (SCLC). We currently plan toinitiate the Phase II clinical trial of NX 473 in mid-2005. The proposed trial wouldbe a randomized trial comparing NX 473 to topotecan in patients with SCLC whoare refractory or resistant to previous platinum-based therapy.  Topotecan is an anti-tumor drug currentlyused off-label as a treatment for SCLC sensitive disease after failure of firstline chemotherapy.  The endpoints of the proposedNX 473 trial would include survival, time to progression, duration of responseand response rate.

 

We also plan to undertake a Phase I/II trial of NX 473in colorectal cancer. The proposed trial would evaluate increasing doses of NX473 in combination with the chemotherapy agents 5-fluorouracil and leucovorinin patients who have faileda 5-fluorouracil/leucovorin chemotherapy regimen. Endpoints would includesafety, response rate (tumor shrinkage), duration of response and time toprogression.  This proposed trialcurrently is targeted to begin in late 2005 or early 2006.

 

The actual times to completion of our STR Phase IIIclinical trial and initiation of our NX 473 clinical program depend uponnumerous factors, including:

 

•               ourability to obtain adequate additional funding;

 

•               approvalsand other actions by the FDA and other regulatory agencies and the timingthereof;

 

•               ourability to open clinical sites;

 

•               ourability to enroll qualified patients into our studies;

 

•               ourability to produce sufficient, reliable and affordable supplies of the STRcompound for 

 

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clinical studies,and to access third-party supplies of holmium-166, the radioactive substanceused in our STR product candidate, as well as other materials used in themanufacture of the STR compound;

 

•               ourability to identify a manufacturer of additional NX 473 drug product;

 

•               theextent of competing trials at the clinical institutions where we conduct ourtrials; and

 

•               theextent of scheduling conflicts with participating clinicians and clinicalinstitutions.

We may not initiate our NX 473 clinical program and advance or completeour STR Phase III clinical trial as projected or achieve successful results.

 

We currently rely on academic institutions andclinical research organizations to conduct, supervise or monitor some or allaspects of clinical trials involving our proposed STR product.  Further, we are seeking to enter into licenseagreements, partnerships or other collaborative arrangements to supportfinancing, development and commercialization of our STR and NX 473 productcandidates. To the extent that we now or in the future participate in suchcollaborative arrangements, we will have less control over the timing, planningand other aspects of our clinical trials. If we fail to advance or complete, orexperience delays in or are forced to curtail our planned clinical programs,our stock price and our ability to conduct our business could be harmed.

 

**If testing of a particular product does not yieldsuccessful results, we will be unable to commercialize that product.**

 

Our research anddevelopment programs are designed to test the safety and efficacy of ourproposed products in humans through extensive preclinical and clinical testing.We may experience numerous unforeseen events during, or as a result of, thetesting process that could delay or prevent commercialization of STR, NX 473 orany other proposed products, including the following:

 

•               the safety andefficacy results obtained in early human clinical trials may not be indicativeof results obtained in later clinical trials;

 

•               the results ofpreclinical studies may be inconclusive, or they may not be indicative ofresults that will be obtained in human clinical trials;

 

•               after reviewingtest results, we or any potential collaborators may abandon projects that wepreviously believed were promising;

 

•               our potentialcollaborators or regulators may suspend or terminate clinical trials if theparticipating subjects or patients are being exposed to unacceptable healthrisks; and

 

•               the effects of ourpotential products may not be the desired effects or may include undesirableside effects or other characteristics that preclude regulatory approval orlimit their commercial use if approved.

 

Clinical testing is very expensive, can take manyyears, and the outcome is uncertain. The data that we may collect from our PhaseIII clinical trial may not be sufficient to support regulatory approval of ourproposed STR product. The clinical trials of STR, NX 473 and other proposedproducts may not be initiated or completed on schedule, and the FDA or foreignregulatory agencies may not ultimately approve any of our product candidatesfor commercial sale. Our failure to adequately demonstrate the safety andefficacy of a cancer therapy product under development would delay or preventregulatory approval of the product, which would prevent us from marketing theproposed product.

 

**Success in early clinical trials may not beindicative of results obtained in later trials.**

 

Results of earlypreclinical and clinical trials are based on a limited number of patients and may,upon review, be revised or negated by authorities or by later stage clinicalresults. Historically, the results from preclinical testing and early clinicaltrials often have not been predictive of results obtained in later clinicaltrials. A number of new drugs and therapeutics have shown promising results ininitial clinical 

 

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trials, but subsequently failed to establishsufficient safety and effectiveness data to obtain necessary regulatoryapprovals. Data obtained from preclinical and clinical activities are subjectto varying interpretations, which may delay, limit or prevent regulatory approval.

 

**We are dependent on suppliers for the timelydelivery of materials and services and may experience future interruptions insupply.**

 

For our STR product to besuccessful, we need sufficient, reliable and affordable supplies of the STRcompound for clinical studies. This requires developing and maintainingreliable and affordable third-party suppliers of commercial quantities ofthe radioactive molecule holmium-166, and the targeting agent DOTMP, used inour STR product candidate. Sources of these materials may be limited, and we,or potential third-party suppliers of the STR compound, may be unable toobtain these materials in amounts and at prices necessary to successfullycommercialize our STR product. Timely delivery of the holmium-166 componentmaterial and of the finished STR compound is critical. For example, holmium-166loses its effectiveness for treating patients within a short period of time. Asa result, the STR product must be shipped within 24 hours of itsmanufacture to the site where the patient is to be treated. Failures or delaysin the manufacturing and shipping processes could compromise the quality andeffectiveness of our product.

 

There are, in general, relatively few sources of theholmium-166 component of our STR product. Historically, we have depended on asingle source vendor, the University of Missouri Research Reactor facilitygroup (MURR) located in Columbia, Missouri. In March 2004, we entered into acontract, under which MURR is responsible for the manufacture, including processqualification, quality control, packaging and shipping, of holmium-166 for our PhaseIII trial.  In November 2004, weexercised our option, with MURR’s consent, to extend the term of the agreementuntil March 1, 2006.  We also have theoption to extend the agreement, with MURR’s consent, for an additional 12-monthterm. The contract may be terminated by either party if the other partybreaches the contract and such breach is not cured, if MURR fails to fulfillour purchase orders on a timely basis, or if any regulatory authority orderseither party to stop manufacturing or using holmium-166.  Under the contract, we pay a fixed price perunit of holmium-166 ordered, subject to certain minimum purchase requirements,and fixed amounts for handling and maintenance. While MURR generally has provided us materials with acceptable quality,quantity and cost in the past, it may become unable or unwilling to meet ourfuture demands, or demands of potential third-party suppliers of our STRcompound. If MURR or an alternate supplier is unable or unwilling to providesupplies of holmium-166 at a cost and on other terms acceptable to us, themanufacture and delivery of our STR product candidate could be impaired, and wemay suffer delays in, or be prevented from, initiating or completing furtherclinical trials of our STR product candidate.

 

We obtain DOTMP, the targeting agent for STR, from TheDow Chemical Company, from which we license the STR technology. Because welicense the STR technology from Dow, we historically have not felt it necessaryto enter into a formal supply agreement with Dow. We believe we currently havea sufficient supply of DOTMP on hand to complete our Phase III study. We planto continue to monitor the stability of the supply over time as trial activityprogresses. If the Phase III trial take significantly longer than anticipatedor the supply is less stable than expected, we may need to take actions toacquire additional supplies of DOTMP.

 

We have a limited supply of NX 473 drug product thatwas manufactured by a prior licensee in September 2004 and earlier.  The drug product has been demonstrated to bestable for 12-18 months from the date of manufacture, which time period is notsufficient to complete our proposed clinical trials of NX 473.  We will need to identify a new manufacturer ofadditional NX 473 drug product to complete our planned Phase II clinical trialin SCLC.  If we are unable to demonstrateincreased stability or identify a new manufacturer for NX 473 on a timely andcommercially reasonable basis, we may be required to delay the clinical trialand the trial expenses may increase. There are a limited number of contractmanufacturers able to make drug products, such as NX 473.  We currently are in the process ofidentifying potential manufacturers of NX 473. There is no assurance that we will be able engage a reliablemanufacturer or to obtain sufficient supplies of NX 473 on a timely orcost-effective basis.

 

In connection with our product development andmanufacturing activities, we rely on third-party contractors to perform for us,or assist us with, certain specialized services, including STR manufacture processsupport and equipment validation at our Denton facility, drug dispensing,distribution and shipping, and clinical trial management. We are not materiallydependent on our relationship with any of 

 

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these contractors. However, because these contractors providespecialized services, their activities and quality of performance may beoutside our direct control. If these contractors do not perform theirobligations in a timely manner, or if we encounter difficulties with thequality of services we receive from these contractors, we may incur additionalcosts and delays in our STR Phase III trial and other product developmentactivities, which could have a material negative effect on our business.

 

**Our current debt obligations may restrict ouroperating and financing flexibility and could, in an event of default, impairour cash resources and assets.**

 

In connection with our 2001 purchase of theradiopharmaceutical manufacturing plant and other assets located in Denton, TX,we assumed $6.0 million of principal amount of restructured debt held by TexasState Bank, McAllen, TX.  The loan, whichmatures in April 2009, is secured by the assets acquired in thetransaction.  The interest rate on theloan was 5.25% on December 31, 2004.  Theinterest rate is equal to the bank prime rate and adjusts as the prime ratechanges.  The loan provides for a maximumannual interest rate of 18%.  Principaland interest are payable in monthly installments.  Principal and interest paid on the note in2004 totaled $486,000.  InDecember 2003, we sold a non-essential portion of our Denton facility, theproceeds of which ($827,000) were applied to reduce the outstanding balance onthe loan. As of December 31, 2004, the outstanding balance of the loan was $4.2million. The fixed monthly payments on the note are recalculated in April ofeach year based on the then current bank prime interest rate and outstandingnote balance. The bank prime interest rate of 4.00% was in effect on thepayment recalculation date in April 2004.  Because the loan is amortized over afourteen-year period from its inception, a principal balance will remain atmaturity in April 2009.  Based on aninterest rate of 5.25%, the estimated principal balance payable at maturitywould be $2.75 million.

 

The terms of the Texas State Bank loan provide that anevent of default may be deemed to occur if we abandon, vacate or discontinueoperations on a substantial portion of the Denton facility or there is amaterial adverse change in our operations. If this were to occur, Texas StateBank could declare the entire outstanding amount of the loan ($4.2 million atDecember 31, 2004) due and immediately payable. In such case, our cashresources and assets could be impaired depending on our ability to raise fundsthrough a sale of the Denton facility and other means. Based on aNovember 2002 appraisal of the Denton facility, we believe the fair valueof the facility and its assets exceeds the amount of the outstanding debt.

 

**If we cannot negotiate and maintain collaborative arrangementswith third parties, our research, development, manufacturing, sales andmarketing activities may not be cost-effective or successful.**

 

Our success will depend in significant part on ourability to attract and maintain collaborative partners and relationships tosupport the development, sale, marketing, distribution and manufacture of STR,NX 473 and any other future product candidates and technologies in the US andEurope. At present, we have two material collaborative agreements.  The first is the exclusive worldwide (exceptin Australia) license granted to us by The Dow Chemical Company for thedevelopment and commercial sale of STR. Under that license, we are solelyresponsible for the development and commercialization of STR. Dow retains theobligation, at its cost, to prosecute patent applications and maintain, extend anddefend all patents. Dow is entitled to certain payments under the license ifand when we receive final approval for commercial sale of STR in variousjurisdictions. After final approval, Dow will be entitled to certain royaltiesand milestone payments based on our annual net sales of STR and relatedproducts. If we are successful in achieving all milestones under the Dowagreement, our total milestone payments to Dow would be $8.5 million. We cannotbe certain of the extent of our success, if any, in commercializing STR andattaining established milestones. The license agreement may be terminated byeither party for breach. We can terminate the license at any time upon priorwritten notice to Dow. Dow may terminate the license if we cease to carry on ourbusiness as a result of liquidation, bankruptcy or insolvency. If not earlierterminated, the license agreement will continue in effect until expiration ofall patents licensed under the agreement. We currently anticipate suchexpiration date to be February 3, 2015. Upon expiration of the Dow licenseagreement, we will retain from Dow a fully paid-up license to use unpatentedtechnology related to STR. If Dow were to breach its obligations under thelicense, or if the license expires or is terminated and we cannot renew,replace, extend or preserve our rights under the license agreement, our STRdevelopment efforts and our business could be significantly adversely affected.

 

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Our second material collaborative agreement is theexclusive worldwide (except Japan) license granted to us by AnorMED, Inc. forthe development and commercial sale of an anti-cancer platinum compound,NX 473.  Under that license, we aresolely responsible for the development and commercialization of NX 473.AnorMED retains the right, at our cost, to prosecute patent applications andmaintain all patents.  The partiesexecuted the license agreement in April 2004, at which time we paid AnorMED aone-time upfront milestone payment of $1.0 million in NeoRx common stock and$1.0 million in cash.  The agreement alsoprovides for additional milestone payments to AnorMED of up to $13 million,payable in cash or a combination of cash and NeoRx common stock. Thesemilestones include our successful completion of an NX 473 Phase II study orinitiation of an NX 473 Phase III study, submission to the FDA of an NDAfor NX 473, regulatory approval from the FDA of NX 473 and theattainment of certain levels of annual net sales of NX 473.  Upon regulatory approval, AnorMED also wouldreceive royalty payments of up to 15% on product sales.  We cannot be certain of the extent of oursuccess, if any, in commercializing NX 473 and attaining establishedmilestones.  Given that the earliest aPhase II study could commence, as stated below, is mid-2005, it is unlikelythat these milestones would be triggered during 2005 or 2006.  Since we cannot predict the length of time tocomplete the first Phase II study, when we would commence a Phase III study orwhen we might submit an NDA for NX 473, we are unable to predict when suchmilestones might be triggered after 2006. The license agreement may be terminated by either party for breach ifthe other party files a petition in bankruptcy or insolvency or forreorganization or is dissolved, liquidated or makes assignment for the benefitof creditors. We can terminate the license at any time upon prior writtennotice to AnorMED. If not earlier terminated, the license agreement willcontinue in effect, in each country in the territory in which the licensedproduct is sold or manufactured, until the earlier of (i) expiration of thelast valid claim of a pending or issued patent covering the licensed product inthat country or (ii) a specified number of years after first commercial sale ofthe licensed product in that country.  Wecurrently plan to initiate a Phase II clinical trial of NX 473 in small celllung cancer in mid—2005 and a Phase I/II trial of NX 473 in colorectal cancerin late 2005 or early 2006. If AnorMED were to breach its obligations under thelicense, or if the license expires or is terminated and we cannot renew,replace, extend or preserve our rights under the license agreement, we would beunable to move forward with our planned NX 473 clinical studies.

 

None of our current employees has any experienceselling, marketing and distributing therapeutic products. To the extent we aresuccessful in obtaining approval for the commercial sale of STR, NX 473 or anyother product candidate, we may need to secure one or more corporate partnersto conduct these activities. We may not be able to enter into partneringarrangements in a timely manner or on terms acceptable to us. To the extentthat we enter into co-promotion or other licensing arrangements, our productrevenues are likely to be lower than if we directly marketed and sold ourproducts, and any revenues we receive would depend upon the efforts of thirdparties, which efforts may not be successful. If we are not able to secureadequate partnering arrangements, we would have to hire additional employees orconsultants with expertise in sales, marketing and distribution. Employees withrelevant skills may not be available to us. Additionally, any increase in thenumber of employees would increase our expense level and could have a materialadverse effect on our financial position.

 

**Any delays in our STR manufacturing operations inDenton, TX, or failure to operate the facility in a cost-effective manner andin accordance with regulatory requirements, could adversely affect our abilityto proceed with our STR Phase III trial on a timely and cost-effective basis.**

 

In April 2001, we purchased a manufacturingfacility and certain other assets located in Denton, TX. In addition to themanufacturing facility, we purchased existing equipment, documentation andcertain processes. The facility is operated in accordance with current GoodManufacturing Practices (cGMP) and was issued appropriate radiation permits bythe Texas Department of Health. This manufacturing facility assumedresponsibility for all aspects of the manufacture of the STR compound,including process qualification, quality control, packaging and shipping, andproduction of the clinical material for our completed STR dosimetry study. Webelieve that the Denton facility has the capabilities and capacity to serve asthe principal manufacturing site for the STR compound for our Phase IIIclinical trial and for potential commercial manufacture.   Our ability to continue to utilize theDenton facility as our primary manufacturing site for the STR compound in thefuture will depend on a number of factors, including:

 

•               actionstaken by the FDA and the timing thereof;

 

•               ourability to obtain adequate additional funding and the timing thereof;

 

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•               ourability to access sufficient, reliable and affordable third-party supplies ofholmium-166;

 

•               thecosts of maintaining manufacturing operations;

 

•               ourability to retain qualified personnel and necessary regulatory permits; and

 

•               theavailability and cost of potential third-party suppliers of STR.

 

If, in the future, we decide to transition the STRproduction process to a third-party supplier, such third-party supplier couldrequire significant start-up time to qualify and implement the manufacturingprocess. In such case, our ability to move forward with further STR clinicaland commercial development could be adversely affected and we may incursignificant additional costs in connection with manufacturing operations. Further,there can be no assurance that manufacturing alternatives would be available ona timely or cost-effective basis.

 

We, or any potential third-party manufacturers, mustcontinuously adhere to cGMP regulations enforced by the FDA through itsfacilities inspection program. If our facilities or the facilities of thesemanufacturers cannot pass a pre-approval plant inspection, the FDA will notgrant an NDA for our proposed products. In complying with cGMP and foreignregulatory requirements, we and any of our third-party manufacturers will beobligated to expend time, money and effort in production, record-keeping andquality control to assure that our products meet applicable specifications andother requirements. If we, or any of our third-party manufacturers, fail tocomply with these requirements, we may be subject to regulatory action.

 

**We facesubstantial competition in the development of cancer therapies and may not beable to compete successfully, and our potential products may be renderedobsolete by rapid technological change.**

The competition fordevelopment of cancer therapies is substantial. There are numerous competitorsdeveloping products to treat the cancers for which we are seeking to developproducts. We initially are focusing clinical development of our STR productcandidate on the treatment of multiple myeloma. Several companies, including Celgene Corp. and Millennium Pharmaceuticals,Inc., also are developing and testing therapeutics for multiple myeloma.  In May 2003, Millennium obtained FDA approvalfor its VelcadeTM therapeutic for treatment of multiple myeloma patents who havereceived at least two prior therapies and demonstrated disease progression onthe last therapy.  Additionally, Quadramet® a radiolabledbone-targeted therapy marketed by Cytogen Corporation to relieve bone pain inpatients with bone cancers, is being investigated at higher doses inconjunction with high dose chemotherapy in multiple myeloma. Many biotechnologycompanies have corporate partnership arrangements with large, establishedcompanies to support research, development and commercialization efforts ofproducts that may be competitive with our product candidates.  Further, a number of establishedpharmaceutical companies, including GlaxoSmithKline, Novartis AG and Bristol-MyersSquibb Co., are developing proprietary technologies or have enhanced theircapabilities by entering into arrangements with, or acquiring, companies withtechnologies applicable to the treatment of cancer.  Many of our existing or potential competitors,have, or have access to, substantially greater financial, research anddevelopment, marketing and production resources than we do and may be betterequipped than we are to develop, manufacture and market competing products. Ourcompetitors may have, or may develop and introduce, new products that wouldrender our technology and proposed STR product less competitive, uneconomicalor obsolete by influencing the degree by which transplantation procedures areused to treat cancer patients.

 

The same competitiverisks will apply to our efforts to develop NX 473 and any other products.  Our initial focus for NX 473 will be in smallcell lung cancer, a disease for which there currently are limited effectivetherapeutic options. Numerous companies, including AstraZeneca PLC, CellTherapeutics, Inc., Exelexis, Inc., ImClone Systems Incorporated, ImmunoGen,Inc., Sanofi-Aventis Group, Inex Pharmaceuticals Corporation, Ipsen Limited, TheMenarini Group, OSI Genetics, Inc. and PharmaMar USA, Inc., also are developingand testing therapeutics for small cell lung cancer. These therapeutics includechemotherapy, inhibitors, monoclonal antibodies, antagonists and interferons. Wecannot assure you that we will be able to effectively compete with these orfuture third party product development programs.

 

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**If we are unable to protect our proprietaryrights, we may not be able to compete effectively, or operate profitably.**

 

Our success is dependentin part on obtaining, maintaining and enforcing our patents and otherproprietary rights and our ability to avoid infringing the proprietary rightsof others. Patent law relating to the scope of claims in the biotechnologyfield in which we operate is still evolving and, consequently, patent positionsin our industry may not be as strong as in other, better-establishedfields. Accordingly, the United States Patent and Trademark Office (USPTO) maynot issue patents from the patent applications owned by or licensed to us. Ifissued, the patents may not give us an advantage over competitors with similartechnologies.

 

We own approximately 100issued United States and foreign patents and have licenses to additionalpatents.  However, the issuance of apatent is not conclusive as to its validity or enforceability and it isuncertain how much protection, if any, will be given to our patents if weattempt to enforce them and they are challenged in court or in otherproceedings, such as oppositions, which may be brought in foreign jurisdictionsto challenge the validity of a patent. A third party may challenge the validityor enforceability of a patent after its issuance by the USPTO. It is possiblethat a competitor may successfully challenge our patents or that a challengewill result in limiting their coverage. Moreover, the cost of litigation touphold the validity of patents and to prevent infringement can be substantial.If the outcome of litigation is adverse to us, third parties may be able to useour patented invention without payment to us. Moreover, it is possible thatcompetitors may infringe our patents or successfully avoid them through designinnovation. We may need to file lawsuits to stop these activities. Theselawsuits can be expensive and would consume time and other resources, even ifwe were successful in stopping the violation of our patent rights. In addition,there is a risk that a court would decide that our patents are not valid andthat we do not have the right to stop the other party from using theinventions. There is also the risk that, even if the validity of our patentswas upheld, a court would refuse to stop the other party on the ground that itsactivities do not infringe our patents.

 

In addition, the protection afforded by issued patentsis limited in duration. With respect to our STR product in development in theUnited States, we currently rely primarily on US patent numbers USPN 4,882,142(expiring December 19, 2008) and USPN 5,059,412 (expiring October 22,2008), both of which are licensed to us by The Dow Chemical Company, and USPN6,767,531 issued to NeoRx (expiring June 12, 2020).  With respect to NX 473, we expect to relyprimarily on US patent number 5,665,771 (expiring February 7, 2016), which islicensed to us by AnorMED.  We may also beable to rely on the Hatch-Waxman Act to extend the term of a US patent coveringSTR or NX 473 after regulatory approval, if any, of such product in the US.

 

Under our licenseagreement with Dow, Dow retains the obligation at its cost, to prosecute patentapplications and maintain, extend and defend all licensed patents. Dow alsoretains the first right to sue any third party infringers of the STR patents.If Dow does not file suit, we have the right to sue the infringer at our ownexpense.  Under our license agreementwith AnorMED, AnorMED retains the right to prosecute patent applications andmaintain all licensed patents, with NeoRx reimbursing such expenses. Under the AnorMEDagreement, we have the right to sue any third party infringers of the NX 473patents in the licensed territory (worldwide except Japan). If we do not filesuit, AnorMED, in its sole discretion, has the right to sue the infringer at itsexpense.

 

In addition to theintellectual property rights described above, we rely on unpatented technology,trade secrets and confidential information. Therefore, others may independentlydevelop substantially equivalent information and techniques or otherwise gainaccess to or disclose our technology. We may not be able to effectively protectour rights in unpatented technology, trade secrets and confidentialinformation. We require each of our employees, consultants and advisors toexecute a confidentiality agreement at the commencement of an employment orconsulting relationship with us. However, these agreements may not provideeffective protection of our information or, in the event of unauthorized use ordisclosure, may not provide adequate remedies.

 

**The use of our technologies could potentiallyconflict with the rights of others.**

 

Our competitors or othersmay have or may acquire patent rights that they could enforce against us. Insuch case, we may be required to alter our products, pay licensing fees orcease activities. If our products conflict with patent rights of others, thirdparties could bring legal actions against us claiming 

 

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damages and seeking to enjoin manufacturing andmarketing of the affected products. If these legal actions are successful, inaddition to any potential liability for damages, we could be required to obtaina license in order to continue to manufacture or market the affected products.We may not prevail in any legal action and a required license under the patentmay not be available on acceptable terms.

 

**We may incur substantial costs as a result oflitigation or other proceedings relating to patent and other intellectualproperty rights.**

 

The cost to us of anylitigation or other proceedings relating to intellectual property rights, evenif resolved in our favor, could be substantial. Some of our competitors may bebetter able to sustain the costs of complex patent litigation because they havesubstantially greater resources. If there is litigation against us, we may notbe able to continue our operations. If third parties file patent applications,or are issued patents claiming technology also claimed by us in pendingapplications, we may be required to participate in interference proceedings inthe USPTO to determine priority of invention. We may be required to participatein interference proceedings involving our issued patents and pendingapplications. We may be required to cease using the technology or licenserights from prevailing third parties as a result of an unfavorable outcome inan interference proceeding. A prevailing party in that case may not offer us alicense on commercially acceptable terms.

 

In April 2003, we received $10 million from the saleto Boston Scientific Corporation (BSC) of certain non-core patents and patentapplications and the grant to BSC of exclusive license rights to certainpatents and patent applications.  BSC originallyasserted four such patents in two lawsuits against Johnson & Johnson, Inc.and certain of its subsidiaries, including Cordis Corporation and GuidantCorporation, alleging infringement of such patents.** **In both lawsuits, the defendantsdenied infringement and asserted invalidity and unenforceability of thepatents.  Boston subsequently withdrewthree of the patents from the litigation. Although we are not currently a party to the lawsuits, our managementand counsel have been deposed in connection with the lawsuits.  It is possible that BSC, if it isunsuccessful or has limited success with its claims against Johnson &Johnson, Inc. and its subsidiaries, may seek damages from us, includingrecovery of all or a portion of the amounts it paid to us in 2003.  We cannot assess the likelihood of whethersuch claim will be brought against us or the extent of recovery, if any, on anysuch claim.

 

**Product liability claims in excess of the amountof our insurance would adversely affect our financial condition.**

 

The testing,manufacturing, marketing and sale of STR, NX 473 and any other proposed cancertherapy products may subject us to product liability claims. We are insuredagainst such risks up to a $10 million annual aggregate limit inconnection with clinical trials of our products under development and intend toobtain product liability coverage in the future. However, insurance coveragemay not be available to us at an acceptable cost. We may not be able to obtaininsurance coverage that will be adequate to satisfy any liability that mayarise. Regardless of merit or eventual outcome, product liability claims mayresult in decreased demand for a product, injury to our reputation, withdrawalof clinical trial volunteers and loss of revenues. As a result, regardless ofwhether we are insured, a product liability claim or product recall may resultin losses that could be material.

 

**Our use of radioactive and other hazardousmaterials exposes us to the risk of material environmental liabilities, and wemay incur significant additional costs to comply with environmental laws in thefuture.**

 

Our research anddevelopment and manufacturing processes, as well as the manufacturing processesthat may be used by our collaborators, involve the controlled use of hazardousand radioactive materials. As a result, we are subject to foreign, federal,state and local laws, rules, regulations and policies governing the use,generation, manufacture, storage, air emission, effluent discharge, handlingand disposal of certain materials and wastes in connection with our use ofthese materials. Although we believe that our safety procedures for handlingand disposing of such materials comply with the standards prescribed by suchlaws and regulations, we may be required to incur significant costs to complywith environmental and health and safety regulations in the future. In theevent that we discontinue operations in facilities that have had past researchand manufacturing processes where hazardous or radioactive materials have beenin use, we may have significant decommissioning costs associated with thetermination of operation of these facilities. These potential decommissioningcosts also may reduce the 

 

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market value of the facilities and may limit ourability to sell or otherwise dispose of these facilities in a timely andcost-effective manner. In addition, the risk of accidental contamination orinjury from hazardous or radioactive materials cannot be completely eliminated.In the event of such an accident, we could be held liable for any resultingdamages, and any such liability could exceed our resources. Our currentinsurance does not cover liability for the clean-up of hazardous wastematerials or other environmental risks.

 

**Even if we bring products to market, changes inhealthcare reimbursement could adversely affect our ability to effectivelyprice our products or obtain adequate reimbursement for sales of our products.**

 

Potential sales of our products may be affected by theavailability of reimbursement from governments or other third parties, such asinsurance companies. It is difficult to predict the reimbursement status ofnewly approved, novel medical products. In addition, third-party payors areincreasingly challenging the prices charged for medical products and services.If we succeed in bringing one or more products to market, we cannot be certainthat these products will be considered cost-effective and that reimbursement tothe consumer will be available or will be sufficient to allow us tocompetitively or profitably sell our products.

 

The levels of revenues and profitability ofbiotechnology companies may be affected by the continuing efforts of governmentand third-party payors to contain or reduce the costs of healthcare throughvarious means. For example, in certain foreign markets, pricing orprofitability of prescription pharmaceuticals is subject to governmentalcontrol. In the United States, there have been, and we expect that there willcontinue to be, a number of federal and state proposals to implement similargovernmental controls. It is uncertain what legislative proposals will beadopted or what actions federal, state or private payors for health care goodsand services may take in response to any health care reform proposals orlegislation. Even in the absence of statutory change, market forces arechanging the health care sector. We cannot predict the effect health carereforms may have on the development, testing, commercialization andmarketability of our proposed cancer therapy products. Further, to the extentthat such proposals or reforms have a material adverse effect on the business,financial condition and profitability of other companies that are prospectivecollaborators for certain of our potential products, our ability tocommercialize our products under development may be adversely affected.

 

**The loss of key employees could adversely affectour operations.**

 

Neile Grayson, PhD, resigned as Vice President,Corporate Development, in January 2004. Although Dr. Grayson was anofficer of the Company, we did not, at the time of her resignation, considerher a key employee in terms of our STR product development activities or otherprograms. We did not experience any material disruptions or delays as aconsequence of the resignation of Dr. Grayson. Dr. Grayson’s position waseliminated and her responsibilities reassigned to other members of management.Melinda G. Kile resigned as Vice President, Finance, effective April 16,2004.  On that date, Michael K. Jacksonwas promoted to Chief Accounting Officer and assumed responsibility for seniorfinancial duties on an interim basis.  Asprincipal financial officer, Ms. Kile was considered a key employee of theCompany; however, we did not experience any material disruptions or delays as aconsequence of Ms. Kile’s resignation. Susan D. Berland was appointed Chief Financial Officer of the Company,effective October 25, 2004.  The positionof Chief Accounting Officer was eliminated as of December 31, 2004, and Mr.Jackson resumed his prior responsibilities as Corporate Controller.

 

Gerald McMahon, Ph.D. was appointed Chief ExecutiveOfficer of the Company, effective May 11, 2004, and was named Chairman of theBoard of Directors in June 2004.  Jack L.Bowman retired from the position as Chief Executive Officer effective May 11,2004, and he did not stand for reelection as a director at the 2004 annualshareholders meeting.  As Chief ExecutiveOfficer, Mr. Bowman was considered a key employee of the Company.  We did not experience any material disruptionor delays as a consequence of Mr. Bowman’s retirement.

As of March 17, 2005, we had a total work force of 43 full-timeemployees and 4 part-time employees. Our success depends, to a significantextent, on the continued contributions of our principal management, scientific,and manufacturing personnel. We have limited or no redundancy of personnel inseveral key development areas, including clinical operations, regulatoryaffairs, quality control and assurance and manufacturing. The loss of theservices of one or more of our employees could delay our 

 

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STR and NX 473 product development activities or other programs andresearch and development efforts. We do not maintain key-person life insuranceon any of our officers, employees or consultants.

 

Competition for qualified employees among companies inthe biotechnology and biopharmaceutical industry is intense. Our future successdepends upon our ability to attract, retain and motivate highly skilledemployees and consultants. In order to commercialize our proposed productssuccessfully, we will in the future be required to substantially expand ourworkforce, particularly in the areas of manufacturing, clinical trialsmanagement, regulatory affairs, business development and sales and marketing.These activities will require the addition of new personnel, includingmanagement, and the development of additional expertise by existing managementpersonnel. Our current financial situation may make it more difficult toattract and retain key employees.

 

We have change in control agreements and severanceagreements with all of our executive officers and consulting agreements withvarious of our scientific advisors. Our agreements with our executive officersprovide for “at will” employment, which means that each executive may terminatehis or her service with us at any time. In addition, our scientific advisorsmay terminate their services to us at any time.

 

**Any weakness identified in ourinternal controls as part of the evaluation being undertaken by us and ourindependent public accountants pursuant to Section 404 of the Sarbanes-OxleyAct of 2002 could have an adverse effect on our business.**

 

Section 404 of the Sarbanes-Oxley Act of 2002 requirespublic companies to evaluate and report on their systems of internal controlover financial reporting. In addition, the independent accountants must reporton management’s evaluation. We have documented and tested our system ofinternal control over financial reporting in 2004 to provide the basis for our management’sevaluation included in this Form 10-K. As a result of our initialdocumentation and testing, we instituted a number of changes in internalcontrol over financial reporting during the fourth quarter of 2004.  These changes include a) increased trainingand review levels for purchase orders and accounts payable transactions toensure proper approval, b) increased training relating to the documentation ofvendor maintenance to ensure the existence of evidence of approval, c)institution of a second review of all check signatures to ensure properlyexecuted check disbursements, d) modification of the approval process for401(k) enrollment forms to ensure proper approval and e) additional training toensure the existence of evidence of Controller's review of interim financialstatements and supporting schedules.  Webelieve that these changes enhanced the consistency and level of our internalcontrol over financial reporting.  Management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2004 has been audited by KPMG LLP, an independentregistered public accounting firm, and KPMG’s report is included in this Form10-K.  Based on this evaluation, we haveconcluded that, as of December 31, 2004, we did not have any materialweaknesses in our internal control over financial reporting and our internalcontrol over financial reporting was effective.

 

Due to the ongoing evaluation and testing of ourinternal controls, there can be no assurance that there may not be significantdeficiencies or material weaknesses that would be required to be reported inthe future. In addition, we expect the evaluation process and any requiredremediation, if applicable, to increase our accounting, legal and other costsand divert management resources from core business operations.  We cannot be certain as to the results oractions related to our on-going evaluation and testing of internal controls, orthe impact of any of them on our operations or stock price.

 

**Risks Related to Our Common Stock**

 

**Our common stock listing was transferred from TheNasdaq National Market to The Nasdaq SmallCap Market; failure to maintaincontinued listing on Nasdaq could affect its market price and liquidity.**

 

Our common stock listingwas transferred from The Nasdaq National Market to The Nasdaq SmallCap Marketon March 20, 2003. We elected to seek a transfer to The Nasdaq SmallCapMarket because we had been unable to regain compliance with The Nasdaq NationalMarket minimum $1.00 bid price requirement for continued listing. Bytransferring to The SmallCap Market, we were afforded an extended grace periodin which to satisfy The SmallCap Market $1.00 minimum bid price requirement. OnMay 6, 2003, we received notice from Nasdaq confirming that we are incompliance with the $1.00 SmallCap minimum bid price requirement. As a resultof rule changes adopted by Nasdaq in March 2003, we will not be eligibleto relist our common stock on The Nasdaq National Market unless and until ourcommon stock maintains a minimum bid price of $5.00 per share for 90consecutive trading days and we otherwise comply with the initial listingrequirements for The Nasdaq National Market. Trading on the Nasdaq SmallCapMarket may have a negative impact on the value of our common stock, becausesecurities trading on the Nasdaq SmallCap Market typically are less liquid thanthose traded on The Nasdaq National Market.

 

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If our common stock isde-listed from The Nasdaq SmallCap Market, we would likely seek quotation onthe American Stock Exchange or a regional stock exchange, if available. Suchlisting could reduce the market liquidity for our common stock. If our commonstock is not quoted on another market or exchange, trading of our common stockcould be conducted in the over-the-counter market on an electronic bulletinboard established for unlisted securities such as the Pink Sheets or the OTCBulletin Board. As a result, an investor would find it more difficult todispose of, or obtain accurate quotations for the price of, our common stock.

 

If our common stock isde-listed from The Nasdaq SmallCap Market, and if we fail to obtain quotationon another market or exchange, and if the trading price remains below $5.00 pershare, then trading in our common stock might also become subject to therequirements of certain rules promulgated under the Securities Exchange Act of1934, which require additional disclosure by broker-dealers in connectionwith any trade involving a stock defined as a “penny stock” (generally, anyequity security not listed on a national securities exchange or quoted onNasdaq that has a market price of less than $5.00 per share, subject to certainexceptions). Many brokerage firms are reluctant to recommend low-priced stocksto their clients. Moreover, various regulations and policies restrict theability of shareholders to borrow against or “margin” low-priced stocks, anddeclines in the stock price below certain levels may trigger unexpected margincalls. Additionally, because brokers’ commissions on low-priced stocksgenerally represent a higher percentage of the stock price than commissions onhigher priced stocks, the current price of the common stock can result in anindividual shareholder paying transaction costs that represent a higherpercentage of total share value than would be the case if our share price were higher.This factor may also limit the willingness of institutions to purchase ourcommon stock. Finally, the additional burdens imposed upon broker-dealersby these requirements could discourage broker-dealers from facilitatingtrades in our common stock, which could severely limit the market liquidity ofthe stock and the ability of investors to trade our common stock.

 

**Our stock price is volatile and, as a result, youcould lose some or all of your investment.**

 

There has been a historyof significant volatility in the market prices of securities of biotechnologycompanies, including our common stock. In 2004, the high and low closing saleprices were $5.78 and $1.43.  The highand low closing sale prices during the period from January 2, 2005 through March17, 2005 were $2.34 and $1.24. Our stock price has been and may continue to beaffected by this type of market volatility, as well as our own performance. Ourbusiness and the relative price of our common stock may be influenced by alarge variety of factors, including:

 

•               announcements by usor our competitors concerning acquisitions, strategic alliances, technologicalinnovations and new commercial products;

 

•               the availability ofcritical materials used in developing and manufacturing our proposed STR and NX473 products;

 

•               the progress andresults of our clinical trials and those of our competitors;

 

•               developmentsconcerning patents, proprietary rights and potential infringement;

 

•               the expense andtime associated with, and the extent of our ultimate success in, securingregulatory approvals; and

 

•               our available cash.

 

In addition, potentialpublic concern about the safety of our proposed STR and NX 473 products and anyother products we develop, comments by securities analysts, our ability tomaintain the listing of our common stock on the Nasdaq system, and conditionsin the capital markets in general and in the life science capital marketspecifically, may have a significant effect on the market price of our commonstock. The realization of any of the risks described in this report, as well asother factors, could have a material adverse impact on the market price of ourcommon stock and may result in a loss of some or all of one’s investment inNeoRx.

 

In the past, securitiesclass action litigation often has been brought against companies followingperiods of volatility in their stock prices. We may in the future be the targetof similar litigation. Securities 

 

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litigation could result in substantial costs anddivert our management’s time and resources, which could cause our business tosuffer.

 

**Certain provisions in our articles ofincorporation and Washington state law could discourage a change of control.**

 

Our articles ofincorporation authorize our board of directors to issue up to 60,000,000 sharesof common stock and up to 3,000,000 shares of preferred stock.  With respect to preferred stock, our boardhas the authority to determine the price, rights, preference, privileges andrestrictions, including voting rights, of those shares without any further voteor action by our shareholders. We currently intend to seek shareholder approvalat our 2005 annual meeting to increase our authorized common stock andpreferred shares.

 

We have adopted a shareholderrights plan, which is intended to protect the rights of shareholders bydeterring coercive or unfair takeover tactics. The board of directors declareda dividend to holders of our common stock of one preferred share purchase rightfor each outstanding share of common stock. In addition, under certaincircumstances, holders of our Series B Convertible Preferred Stock areentitled to receive one preferred share purchase right for each share of commonstock into which their Series B preferred stock may be converted. Therights are exercisable ten days following the offer to purchase or acquisitionof beneficial ownership of 20% of the outstanding common stock by a person orgroup of affiliated persons. Each right entitles the registered holder, other thanthe acquiring person or group, to purchase from NeoRx one-hundredth of oneshare of Series A Junior Participating Preferred Stock at the price of$40, subject to adjustment. The rights expire April 10, 2006. In lieu ofexercising the right by purchasing one one-hundredth of one share ofSeries A preferred stock, the holder of the right, other than theacquiring person or group, may purchase for $40 that number of shares of ourcommon stock having a market value of twice that price.

 

Washington law imposesrestrictions on certain transactions between a corporation and significantshareholders. Chapter 23B.19 of the Washington Business Corporation Actprohibits a target corporation, with some exceptions, from engaging inparticular significant business transactions with an acquiring person, which isdefined as a person or group of persons that beneficially owns 10% or more ofthe voting securities of the target corporation, for a period of five yearsafter the acquisition, unless the transaction or acquisition of shares isapproved by a majority of the members of the target corporation’s board ofdirectors prior to the acquisition.  Prohibitedtransactions include, among other things:

 

•               a merger orconsolidation with, disposition of assets to, or issuance or redemption ofstock to or from the acquiring person;

 

•               termination of 5%or more of the employees of the target corporation; or

 

•               receipt by theacquiring person of any disproportionate benefit as a shareholder.

 

A corporation may not optout of this statute. This provision may have the effect of delaying, deterringor preventing a change in control of NeoRx or limiting future investment inNeoRx by significant shareholders and their affiliates and associates.

 

The provisions of ourarticles of incorporation, shareholder rights plan and Washington law discussedabove may have the effect of delaying, deterring or preventing a change ofcontrol of NeoRx, even if this change would be beneficial to our shareholders.These provisions also may discourage bids for our common stock at a premiumover market price and may adversely affect the market price of, and the votingand other rights of the holders of, our common stock. In addition, theseprovisions could make it more difficult to replace or remove our currentdirectors and management in the event our shareholders believe this would be inthe best interests of the corporation and our shareholders.

 

**Certain provisions of our Series BConvertible Preferred Stock may prevent or make it more difficult for us to raisefunds or take other actions**

 

Certain provisions of thePreferred Stock and Warrant Purchase Agreement and Certificate of Designationfor our Series B Convertible Preferred Stock may require us to obtain theapproval of the holders of Series B preferred stock to amend, alter orrepeal any provision of the Certificate of 

 

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Designation which may be deemed to materiallyadversely affect the rights of the holders of Series B preferred stock orto authorize, create or issue any class or series of securities havingliquidation or other rights superior to those of the Series B preferredstock. The Series B preferred stock also contains provisions requiring theadjustment of the conversion price if we issue (other than in connection withcertain permitted transactions, such as strategic collaborations andacquisitions approved by the board of directors or transactions approved by amajority of the holders of the Series B preferred stock) shares of common stockat prices lower than the conversion price. This means that if we need to raiseequity financing at any time when the prevailing or discounted market price forour common stock is lower than the conversion price, the conversion price willbe reduced and the dilution to shareholders increased. These provisions maymake it more difficult for our management or shareholders to take certaincorporate actions and could delay, discourage or prevent future financings.These provisions could also limit the price that certain investors might bewilling to pay for shares of our common stock.

 

The outstanding shares of Series B preferred stock, ata conversion price of $5.00 per share, were convertible into 3,150,000 sharesof common stock as of December 31, 2004.  Giving effect to the antidilution adjustment occurring as a result ofour March 2005 common stock financing, the outstanding shares of Series Bpreferred stock currently have a conversion price of $4.578 per share and areconvertible into 3,438,865 3,446,389 shares of common stock.   In addition, warrants accompanying theSeries B preferred stock, at an exercise price of $6.00 per share, areexercisable into 630,000 shares of common stock. These shares of common stock,when issued upon conversion of the Series B preferred stock and exercise of thewarrants will be registered with the SEC and generally available for immediateresale in the public market. The market price of our common stock could fall asa result of such resales due to the increased number of shares available forsale in the market.

 

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***Item 1.  BUSINESS***

 

### **The Company**

NeoRx is a biotechnologycompany dedicated to the development and commercialization of cancer therapy products.Our major research and development program in 2004 was STRTM, abone-targeting radiotherapeutic. In 2004, we acquired NX 473, a platinumcompound, for which we currently plan to initiate a clinical program in mid-2005.

 

Our STR program isin Phase III clinical development for treatment of primary refractory multiplemyeloma (myeloma that has not been responsive to conventional first-linechemotherapy).  Multiple myeloma is acancer of the body’s antibody-producing cells originating in the bonemarrow. STR is designed to deliver radiation specifically to sites of cancer inthe bone and bone marrow. This reduces exposure of healthy tissues other thanbone to the potentially toxic effects of the radiation. Our proposed STRproduct consists of a bone-seeking molecule called DOTMP, which deposits theradioactive substance, holmium-166, in the skeleton. STR has also beenevaluated in an investigator-sponsored study of patients with breast cancermetastasized to the bone. We plan to initiate a Phase II trial to examine STRin a larger group of breast cancer patients with bone metastases. The trial currentlyis targeted to begin in the first half of 2005.  We produce STR for our Phase III trial at ourmanufacturing facility in Denton, Texas.

 

We are developingSTR for use with high-dose chemotherapy and stem cell transplantation.High-dose chemotherapy and stem cell transplantation, using the patient’s ownstored stem cells, currently offer myeloma patients the best chance to achievea complete response to therapy. A complete response to therapy occurs if acharacteristic myeloma protein in the patient’s blood completely disappears. Acomplete response has been shown in numerous studies to be associated with abetter chance of long-term survival. However, according to data from theInternational Blood and Marrow Transplant Registry, the proportion of patientswho achieve a complete response to high-dose chemotherapy and stem celltransplantation is typically 30% or less, and the overall survival of patientsat three years after transplantation is approximately 53%. We believe thatadding STR to high-dose chemotherapy and stem cell transplantation may increasepatient long-term survival without adding to the toxic effects caused by thesetreatments.

In April 2004, we acquired rights to develop, manufacture andcommercialize NX 473,a platinum-based drug to treat various types of cancer. In October 2004, we filedan IND with the FDA for a Phase II clinical trial of NX 473 for the treatmentof patients with small cell lung cancer. We currently plan to initiate the PhaseII clinical trial of NX 473 in mid-2005.  In addition, we currently plan to start a studyof NX 473 in patients with metastatic colorectal cancer in late 2005 or early2006. In Phase II trials conducted by others, NX 473 has been shown to beactive in a variety of cancers, including ovarian cancer, lung cancer andprostate cancer. In addition, NX 473 has shown evidence of activity in bothplatinum-sensitive and resistant/refractory disease. NX 473 also exhibits thepotential to be formulated for both oral and intravenous delivery. Clinicalstudies to date indicate that NX 473 has an acceptable safety profile and doesnot appear to be associated with kidney or peripheral nervous system toxicitiescharacteristic of other marketed platinum-based therapies.

 

We have financed our operations primarily through thesale of equity securities, technology licensing, collaborative agreements anddebt instruments.  We invest excess cashin investment securities that will be used to fund future operating costs.  Cash, cash equivalents and investmentsecurities totaled $17.8 million at December 31, 2004 compared to $27.5 millionat December 31, 2003.  We primarily fundcurrent operations with our existing cash and investments.  Cash used to fund operating activities for the twelve months endedDecember 31, 2004 totaled $17.5 million. Revenues and other income sources for 2004 were not sufficient to coveroperating expenses.

We raised approximately $3.9 million in net proceeds fromthe sale of common stock and warrants in a private placement transaction on March7, 2005.  We intend to use the netproceeds from this financing added to our existing funds to support our PhaseIII trial in STR, to initiate a Phase II trial in NX 473 in small cell lungcancer and for general working capital. With the proceeds of this offering, we had total cash and marketablesecurities of $17.8 million at March 7, 2005.

 

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Since our inception in 1984, we have dedicated substantiallyall of our resources to research and development.  We have not generated any significant revenuefrom product sales to date and have operated at a loss in each year of ourexistence.  We had a net loss of $19.4 millionfor the year ended December 31, 2004, a net loss of $5.1 million for the yearended December 31, 2003, and a net loss of $23.1 million for the year endedDecember 31, 2002.  We expect our lossesto continue in the future as we expand our clinical trials and increase ourresearch and development activities.  Wewill need to raise additional capital to complete our research and developmentactivities and commercialize STR, NX 473 or other proposed products.  Clinical studies are inherently uncertain,and our Phase III trial of STR may not confirm the results we achieved in ourearlier clinical trials.  If STR or anyfuture proposed products are not shown to be safe and effective, we will notreceive the required regulatory approvals for commercial sale of suchproducts.  Further, we may not be able tomanufacture STR or other proposed products in commercial quantities or marketsuch products successfully.

 

Our consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States, assuming that we willcontinue as a going concern. While management believes that current cash andcash equivalent balances, and any net cash provided by operations, may provideadequate resources to fund operations at least until December 31, 2005, thismay not be the case.  Management istherefore exploring a number of alternatives to enable us to continue operatingincluding:

 

•                    raisingadditional capital to fund continuing operations by private placements or othersales of equity or debt securities or through the establishment of otherfunding facilities;

 

•                    enteringinto strategic collaborations, which may include joint ventures or partnershipsfor product development and commercialization, merger, sale of assets or othersimilar transactions; and

 

•                    obtainingadditional capital resources to fund operations through cost cuttingmechanisms, including the delay, reduction or curtailment of our current andplanned STR and NX 473 development programs.

 

We have no assurance thatany of these alternatives will be successful. We may not be able to obtain the required additional capital or enterinto relationships with corporate partners on a timely basis, on favorableterms, or at all.  Conditions in thecapital markets in general, and the life science capital market specifically,may affect our potential financing sources and opportunities for strategicpartnering.

 

*Cancer and its Treatment*

 

Cancer is a broad group of diseases characterized by theuncontrolled growth and spread of abnormal cells.  Cancer cells have the ability to migrate fromtheir sites of origin to invade and damage other tissues and organs, through aprocess called metastasis.  The AmericanCancer Society estimated that about 1,373,000 new cancer cases would bediagnosed in the United States in 2005, and 570,000 Americans would die fromcancer in 2005.  Following heart disease,cancer is the second leading cause of death in the United States and in manyother industrialized nations.  Theincidence of cancer is expected to increase in the coming decades, as lifeexpectancies continue to increase in the industrialized world.

There is considerableneed for new cancer treatments, as well as treatments that provide animprovement to existing therapies. In recent years many new classes of agents thatprovide modest increases in patient survival have been approved for use.  It is anticipated that the use of multipleagents, either in combination or in sequence, will continue to provide benefitto cancer patients who have been diagnosed with disease.  In addition, we believe that individualizedtherapies will become more prominent as tumor diagnosis and agents withdifferent mechanisms of anti-cancer effect are approved and become available tothe practicing oncologist.  We alsoanticipate that early diagnosis and cancer prevention will allow forinterventions that will allow patients to live longer and have a better qualityof life.  Current treatments for cancerinclude surgery, external-beam radiation and chemotherapy, including targetedpharmaceuticals, hormone therapy, cytokines, interferons, antibodies, andantibody-based radiotherapeutics. There has been substantial recent success inthe combined use of both traditional chemotherapeutics, which generally destroyscells, and targeted agents which are generally combined with more conventionalchemotherapeutics for maximum effect. Occasionally, both chemotherapeutics and targeted agents are used asstand-alone agents in the treatment of human cancers.

**STRTM (Skeletal Targeted Radiotherapy)**

 

*Multiple Myeloma and the Lack of Effective Treatments*

 

NeoRx is developing STRTM (bone-targetingradiotherapeutic) for use with high-dose chemotherapy and autologous(self-donor) stem cell transplantation (SCT) for treatment of multiple myelomaand potentially other bone and bone marrow-related cancers.  Multiple myeloma is a cancer of the plasmacells, the antibody-producing cells originating in the bone marrow.  The disease is characterized by impairedblood cell formation, multiple tumor sites in the bone marrow, and widespreadbone lesions that result in 

 

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bone pain and fractures.  Multiple myeloma typically strikesbetween ages 65 and 70, although there is a recent trend towards an earlier ageof onset. Multiple myeloma is the second most common blood cancer.  The American Cancer Society estimated that,in the United States during 2005, approximately 15,900 new cases of multiplemyeloma will be diagnosed and 11,300 patients will die from the disease.

 

There is a significant unmetmedical need for effective treatments for multiple myeloma.  Available and emerging myeloma drugsmay prolong life and relieve pain and other symptoms, but are notcurative.  Moreover, existing treatmentshave serious side effects, and not all patients are candidates for treatmentbecause of these side effects.  Immunomodulatoryagents (drugs that affect the immune system) such as thalidomide and proteosomeinhibitors such as bortezomib (VelcadeTM),are in development for front-line therapy for patients with relapseddisease.  However, as single agents thesenew drugs provide a low complete response (CR, or complete remission) rate,generally less than 5%.  These drugs canalso cause blood clots and nervous system toxicities. Even with achievement ofremission following treatment with these drugs, all patients eventuallyexperience relapse of their disease due to proliferation of resistant myelomacells.  Fewer than 5% of patients survivemore than 10 years after diagnosis.

 

Myeloma cells are sensitive to radiation. Externalbeam radiation is used to treat localized bony disease. However, total bodyirradiation (TBI), the conventional method of delivering radiation therapy tonon-localized disease, can result in high exposure of non-target tissues andserious side effects, limiting the ability to deliver an effective therapeuticdose to the patient.  Although widelyused in the past in conjunction with high-dose chemotherapy treatment regimensfor multiple myeloma, TBI has not been demonstrated to provide a benefit inlong-term disease control.  We believethat the ability to target radiation therapy directly to myeloma tumor siteswould enable delivery of more effective doses, with fewer side effects.

 

Currently, the primary treatmentfor multiple myeloma is chemotherapy, which may be followed by high-dosechemotherapy and autologous SCT in eligible patients. Approximately one-thirdof multiple myeloma patients respond poorly or not at all to initialchemotherapy (primary refractory patients). These patients generally have apoor outcome.  The CR rate to subsequentconventional-dose second-line chemotherapies is low, and survival of thesepatients is limited.

 

High-dose chemotherapy withautologous SCT has become the standard of care for patients with goodperformance status, and offers multiple myeloma patients the best chance for aCR to therapy.  According to theInternational Bone Marrow Transplant Registry (IBMTR), an estimated 10,500multiple myeloma patients were treated with this regimen in the North Americain 2002. High-dose therapy with autologous SCT involves collection of thepatient’s peripheral blood stem cells, followed by a preparative regimen withhigh-dose chemotherapy that destroys healthy bone marrow cells while destroyingthe myeloma cells.  Subsequenttransplantation of the patient’s stem cells allows reconstitution of the bonemarrow so that normal blood cell production can resume.  High-dose chemotherapy with autologous SCT hasbeen shown to improve CR rates, progression-free survival, and overallsurvival. However, many patients do notachieve a CR to this therapy; depending on definition of response criteria, CRsto SCT are achieved in approximately 20% to 30% of myeloma patients whoresponded well to initial chemotherapy, and the overall survival ofpatients three years after transplantation is approximately 53%.  Furtherincreasing the chemotherapy dose in transplant regimens potentially may increaseresponse rates, but this approach is not practical because current high-dosechemotherapy regimens already are at the limits of tolerance.

 

We believe thatadding targeted radiation therapy, by means of STR, to high-dose chemotherapyand autologous SCT may increase rates of CR to therapy and long-term survivalwithout adding to the toxic effects of this regimen. We anticipate that overthe next several years, about half of all newly-diagnosed, treatment-eligiblemultiple myeloma patients will be candidates for high-dose chemotherapy andSCT, following response to initial chemotherapy.  An additional number of patients who are poorresponders to initial chemotherapy, and relapsed patients undergoingsecond-line therapy, also may be candidates for SCT.  We also expect that new cytostatic agents,such as thalidomide and bortezomib (VelcadeTM),may gain use in initial therapy.  Becausecytostatic agents are generally not toxic to the bone marrow, these agents havethe potential to increase the number of patients who are eligible fortransplant later in the course of their disease.

 

In addition to multiplemyeloma, STR with high-dose chemotherapy and SCT has the potential to improvepatient outcomes in other cancers where stem cell transplantation is indicated.For example, 

 

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primarybone cancers such as Ewing’s sarcoma and cancers that metastasize to the bone,such as breast, lung and prostate cancer, are potential indications forSTR.  Acute leukemias, non-Hodgkin’slymphoma, and other cancers of the bone marrow also are potential indicationsfor STR.  According to the IBMTR,approximately 8,200 patients with leukemia and lymphoma were treated with SCTin the United States in 2002.

 

*The STRConcept*

STR is designed todeliver high doses of radiation therapy to tumor sites throughout the skeleton,producing both a direct therapeutic effect on disseminated disease sites and ageneral marrow-ablative effect. The goal of STR is to achieve high completeresponse (CR) rates in transplant-eligible patients in order to increaselong-term disease-free survival and overall survival.  There is a body of published evidencecorrelating longer median overall survival with the achievement of a CR afterhigh-dose chemotherapy and stem cell transplantation (SCT) in multiple myelomapatients. STR seeks to improve upon the CR rates achieved with high-dosechemotherapy and SCT, and thus improve patient survival.

STR targets boneand adjacent marrow with the bone-seeking molecule, DOTMP, stably complexedwith a radioactive substance called holmium-166.  The high energy of holmium-166 allows optimalpenetration of marrow and bone disease sites, while its short half-lifeminimizes the time required between treatment and SCT.  Upon administration, STR localizes almostexclusively to the bone.  Thislocalization brings high doses of radiation in close proximity to multiplemyeloma tumor cells.  The radiationdestroys the DNA of the cells, preventing the rapid replication associated withtumor growth.  STR that does not localizeto the bone is eliminated through the kidneys shortly after administration.

 

*STR Clinical Development*

 

We completed Phase I/IIdose escalation studies of STR in combination with high-dose chemotherapy(melphalan) and autologous SCT in 83 patients with multiple myeloma in2000.  In October 2000, the FDAplaced all of our clinical trials of STR on clinical hold because of a serioustoxicity that developed in about 10% of patients treated with STR in our PhaseI/II trials. This toxicity, which is called thrombotic thrombocytopenicpurpura/hemolytic uremic syndrome (TTP/HUS), emerged six to 13 monthsafter treatment.  TTP/HUS is a syndromethat sometimes occurs in patients conditioned for bone marrow transplant withtotal body irradiation. It is believed to be caused, at least in part, byradiation injury to the kidneys. Of the seven patients who developed TTP/HUSbelieved to be related to treatment with STR, two were alive at last follow-upin 2004. Three patients died with disease progression, making it difficult todetermine the cause of death, and two patients died without diseaseprogression, suggesting that TTP/HUS may have been a cause of death. Ourstudies indicated that the occurrence of drug-related TTP/HUS in the Phase I/IItrials was dependent on the dose of STR administered. The lowest dose at whichdrug-related TTP/HUS occurred was 938 mCi/m2. We reduced the dose inour Phase III trial to 750 mCi/m2. No cases of drug-related TTP/HUShave been seen among the fifteen patients treated in the Phase I/II studies atcomparable doses of STR.

 

As a condition to lifting the clinical hold, the FDArequested that we collect additional data from a small number of multiplemyeloma patients to validate the patient-specific dosing method we usedin earlier studies of STR and which we planned to use in our proposed Phase IIItrial.  In addition, the FDA asked us to conducta dosimetry study to quantify the exposure of certain organs, including thekidney, the bone and the bone marrow, to radiation from STR.  The study also used an adjusted radiationdosage and a revised administration regimen.

 

We completed the required studies in late 2002 andsubmitted data to the FDA in February 2003. At that time, we also submitted aproposal for further clinical development of STR in multiple myeloma patientswith primary refractory myeloma (myeloma that has not been responsive toconventional first-line chemotherapy). The FDA lifted the clinical hold inApril 2003.   In October 2003, we reachedagreement with the FDA on our STR Phase III clinical trial design. This agreement,called a Special Protocol Assessment (SPA), established the number of patientsto be studied and how and when the drug’s safety and effectiveness will bedetermined.  The SPA process is intendedto provide assurance that if pre-specified trial results are achieved, they mayserve as the primary basis for an efficacy claim in support of a New DrugApplication (NDA). The FDA also confirmed that a single Phase III trial issufficient to obtain marketing approval for STR, provided that the drug isshown to be safe and effective in the trial. Although the FDA has agreed to accept complete response as a surrogateendpoint for efficacy in the Phase III 

 

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trial, we are required to follow the Phase III patients for survival asour Phase IV (post-marketing) commitment.

 

The Phase III trial under the SPA is a randomized,controlled study of STR in patients with primary refractory multiplemyeloma.  These are patients who havefailed to achieve at least a partial response to conventional chemotherapy andhave been undergoing treatment for less than 18 months. The trial is expectedto enroll approximately 240 evaluable patients, half on the experimental armand half on the control arm.  Patients onthe experimental arm will receive STR plus the chemotherapy drug melphalan,followed by autologous SCT.  Patients onthe control arm will receive melphalan only, followed by SCT.

 

The FDA accepted complete response at six monthspost-transplant as a surrogate endpoint for the Phase III study. The usualendpoint of oncology trials of this nature is patient survival, determined bycomparing the median length of survival of the patient population that receivesthe experimental treatment to the median length of survival of the patientpopulation that receives conventional treatment.  Complete response at six monthspost-transplant is an endpoint that can be measured earlier than survival andtherefore may shorten the timeline for seeking regulatory approval.  The FDA’s acceptance of a surrogate endpointplaces STR on the Accelerated Approval path. Accelerated Approval is intendedto make promising products for life-threatening diseases available earlier inthe course of development, by allowing approval on the basis of a clinicalendpoint other than patient survival.

 

We opened the Phase IIItrial of STR to patient enrollment in March 2004.  We anticipate that the Phase III trial willtake several years to complete, and we do not expect to submit a New DrugApplication (NDA) for the potential approval of STR to the FDA before 2008.  The actual time to completion of our STR PhaseIII clinical trial will depend upon numerous factors, including our ability toopen clinical sites and enroll qualified patients into the trial, our abilityto obtain additional capital to fund the trial, our ability to manufacture theSTR compound and distribute it to the clinical sites on a timely basis, and actionsby the clinical institutions, the FDA and other regulatory agencies.

There are presently 20 clinical sites open and we planto have as many as 40 clinical sites participating in the trial.  We have prioritized the list of prospectiveclinical sites according to their readiness, experience and projected rate ofpatient accrual, and are working to open them on a rolling basis.  There are a very limited number of patientswith primary refractory myeloma who will be qualified for enrollment in our PhaseIII clinical trial and that number may become more limited if emergingtherapies are more effective than existing therapies.  Initial patient accrual in our Phase III trialhas progressed more slowly than expected. We have undertaken a number of measures, including a substantial patientand community oncologist outreach program, to make referring physicians andpatients more aware of STR and the Phase III trial. We also are working withthe FDA to amend the eligibility criteria for our trial as a means ofpotentially increasing enrollment. If our efforts are not successful or otherfactors outlined above adversely affect our efforts, the date of our submissionof an NDA could be substantially delayed.

Total estimatedcosts to complete the STR clinical trial and potentially obtain marketingapproval are in the range of $35-40 million, including the cost of clinicaldrug supply.  These costs could besubstantially higher if we have to repeat, revise or expand the scope of ourtrials, or conduct additional clinical trials not presently planned, to securemarketing approvals.  These estimatedcosts exceed our current capital resources, and we will be required to obtainadditional funding to complete the STR clinical trial.  Moreover, clinical studies are inherentlyuncertain, and our Phase III trial may not confirm the results we achieved inour earlier clinical trials.  If STR isnot shown to be safe and effective, we will not be able to obtain the requiredregulatory approvals for commercial sale of that product.

 

The FDA has designatedSTR as an orphan drug for the treatment of multiple myeloma, under theprovisions of the Orphan Drug Act, as amended.  To qualify for orphan drug status, a proposed drug must be intended foruse in the treatment of a condition that affects fewer than 200,000 people inthe United States.  Orphan drug statusentitles us to exclusive marketing rights for STR in the United States forseven years following market approval, if any, and qualifies us for researchgrants to support clinical studies, tax credits for certain research expensesand an exemption from certain application user fees. As discussed below in thesection entitled “Government Regulation and Product Testing,” the manufactureand marketing of STR are subject to regulation for safety, efficacy and qualityby the FDA and comparable authorities in other countries.

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In December 2004, weannounced updated data from the completed Phase I/II trials of STR. These PhaseI/II trials involved 83 patients with multiple myeloma at various clinicalstages who received various doses of STR and melphalan prior to autologous stemcell transplantation. In the Phase I/II trials, among the 10 patients whoreceived STR at a dose of 750 mCi/m2 (the dose selected for our Phase IIIstudy) with melphalan and stem cell transplantation, we observed a completeresponse rate of 40%, and a three-year survival rate of 90%. The four-yearsurvival rate for these patients was found to be 70%.  We believe that these results comparefavorably with data from the International Blood and Marrow Transplant Registry,which reports a three-year survival rate of approximately 53% for myelomapatients receiving standard chemotherapy and transplant regimens. Otherpublished data indicate a median survival of 4.6 years for patents treated withtraditional chemotherapy and transplant.

*STR and Breast Cancer*

Inaddition to multiple myeloma, STR has been studied as a treatment for patientswith breast cancer that has spread to the bone. Breast cancer metastasizes, or spreads, to the bone in 30-85% ofpatients and may be the only site of metastasis in 25-50% of patients.  Breast cancer patients with bone metastasesmay be treated with hormonal therapy, chemotherapy or external beamirradiation.  Breast cancer patients withbone metastases typically experience treatment failure within 139-220 days**. **Researchers at MDAnderson Cancer Center conducted an investigator-initiated Phase I dose-escalation study of STR involving six patientswith stage IV breast cancer metastasized to the bone. Patients wereadministered STR as a single agent followed by autologous stem cell transplant.As of February, 2005, two of the six patients remain alive, without progressionof their disease up to six years post-transplant. Among the other fourpatients, the overall median time to disease progression was approximately 300days. Disease relapse in these four patients occurred in tissues outside thebone.

Based on the results from this study, we plan toconduct a Phase II trial to examine STR in a larger group of breast cancerpatients with bone metastases. The trial is currently targeted to begin in the firsthalf of 2005.

 

*STR Manufacturing*

 

In April 2001, wepurchased a radiopharmaceutical manufacturing facility and certain other assetslocated in Denton, Texas. In addition to the manufacturing facility, wepurchased existing equipment, documentation and certain processes. The facilityis operated in accordance with current Good Manufacturing Practices (cGMP) andwas issued appropriate radiation permits by the Texas Department of Health. Thismanufacturing facility is responsible for all aspects of the manufacture of theSTR compound, including process qualification, quality control, packaging andshipping, and production of the clinical material for our STR clinical trialactivity.  As of March 17, 2005, we had astaff of 13 full-time employees at the Denton facility.

Our manufacturingfacility must continuously adhere to cGMP regulations enforced by the FDAthrough its facilities inspection program. If our facilities cannot pass apre-approval plant inspection, the FDA will not grant an NDA for STR or anyother proposed products.  Therequirements of cGMP and comparable regulations are discussed below in thesection entitled “Government Regulation and Product Testing.”

*Single Source Suppliers*

In order to manufacture the STR compound, we needreliable and affordable third-party suppliers of commercial quantities of theradioactive molecule, holmium-166, and the targeting agent, DOTMP, used in ourSTR product.

 

There are, in general, relatively few sources of theholmium-166 component of our STR product. Historically, we have depended on asingle source vendor, the University of Missouri Research Reactor facilitygroup (MURR) located in Columbia, Missouri. In March 2004, we entered into acontract, under which MURR is responsible for the manufacture, includingprocess qualification, quality control, packaging and shipping, of holmium-166for our Phase III trial.  In November2004, we exercised our option, with MURR’s consent, to extend the term of theagreement until March 1, 2006. We also have the option to extend the agreement,with MURR’s consent, for an additional 12-month term. The contract may 

 

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be terminated by either party if the other party breaches the contractand such breach is not cured, if MURR fails to fulfill our purchase orders on atimely basis, or if any regulatory authority orders either party to stopmanufacturing or using holmium-166.  Underthe contract, we pay a fixed price per unit of holmium-166 ordered, subject tocertain minimum purchase requirements, and fixed amounts for handling andmaintenance.  While MURR generally hasprovided us materials with acceptable quality, quantity and cost in the past,it may become unable or unwilling to meet our future demands, or demands ofpotential third-party suppliers of our STR compound. If MURR or an alternatesupplier is unable or unwilling to provide supplies of holmium-166 at a costand on other terms acceptable to us, the manufacture and delivery of our STRproduct candidate could be impaired, and we may suffer delays in, or beprevented from, initiating or completing further clinical trials of our STRproduct candidate.

 

# **We obtain DOTMP, the targetingagent for STR, from The Dow Chemical Company, from which we license the STRtechnology.  Alternate suppliers of DOTMPare available if needed.  Because welicense the STR technology from Dow, we historically have not felt it necessaryto enter into a formal supply agreement with Dow. We believe we currently havea sufficient supply of DOTMP on hand to complete our Phase III study. We planto continue to monitor the stability of the supply over time as trial activityprogresses. If the trial take significantly longer than anticipated or thesupply is less stable than expected we may need to take actions to acquireadditional supplies of DOTMP.**

 

**NX 437 Platinum Compound**

 

*Platinum Anti-Cancer Agents and the NX 473 Concept*

In April 2004, we acquired rights to develop, manufacture andcommercialize NX 473,a next-generation platinum-based cancer therapy.  Platinum-based chemotherapies have gainedwide use since their introduction nearly 20 years ago. Today,platinum-containing therapies such as cisplatin, carboplatin, and oxaliplatinare used to treat a wide variety of solid tumors such as testicular, ovarian,colorectal, lung, and head and neck cancers. Platinums are used both as single-agent therapies and in combinationwith other therapies, including targeted antibody agents.  Platinum drugs destroy cancer cells bybinding to DNA, causing damage which, if too severe to be repaired byintracellular systems, triggers apoptosis (programmed cell death).  The worldwide market for platinum-basedcancer drugs is estimated to be over $1 billion.

A significantshortcoming of available platinum agents is that many tumors are intrinsicallyresistant or acquire resistance to these drugs. Available platinum drugs also have undesirable side effects andtoxicities that limit their use.  Becauseof these considerations, newer generations of platinum compounds that overcomeplatinum resistance or safety concerns when used in combination with, or inaddition to, current combination treatment regimens are needed.

NX 473 wasdeveloped specifically to overcome known platinum resistance mechanisms and hasshown promise in preclinical and clinical studies to date.  In Phase II trials conducted by a priorlicensee, NX 473 was been shown to be active in a variety of cancers, includingovarian cancer, lung cancer and prostate cancer.  In addition, NX 473 has shown evidence ofactivity in both platinum-sensitive and resistant/refractory disease.  Clinical studies to date also indicate thatNX 473 has an acceptable safety profile, and less toxicity to the kidney andperipheral nervous system than certain other widely used platinum drugs.  NX 473 further exhibits the potential to beformulated for both oral and intravenous delivery.

 

*Proposed NX 473 Clinical Program*

In October 2004,we filed an investigational new drug application (IND) with the FDA for a PhaseII clinical trial of NX 473 for the treatment of patients with small cell lungcancer (SCLC).  We currently plan toinitiate this trial in mid-2005. The proposed trial would be a randomized trialcomparing NX 473 to topotecan in patients with SCLC who are refractory orresistant to previous platinum-based therapy. As described below, topotecan is an anti-tumor drug currently usedoff-label as a treatment for platinum resistant/refractory SCLC disease afterfailure of first-line chemotherapy. The endpoints of the proposed NX 473 trialwould include response rates, survival, time to progression, duration ofresponse and tumor symptom improvement. Because this is a Phase II trial, it would not be designed to detect 

 

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statisticallysignificant differences in these endpoints. The purpose of the Phase II trial would be to collect additional dataabout response rate and survival endpoints by studying a larger number of SCLCpatients.

 

*Small Cell Lung Cancer and the Lack of EffectiveTreatment*

There is a significant unmet medical need for effective treatments forsmall cell lung cancer (SCLC). Lung cancer is the most common cause of cancer deathin the United States.  SCLC, whichaccounts for approximately 15% of all lung cancer cases, is the most aggressiveand lethal form of lung cancer.  Themedian survival of patients with untreated small cell lung cancer is 6 to 8weeks. Combination chemotherapy is currently considered standard therapy forSCLC, especially with regimens involving platinum and etoposide.  Reported response rates to first-linecombination chemotherapy are relatively high (70% to 80%), with a medianduration of response of 9 to 12 months and a median survival of 11 to 18months.  Unfortunately, despite the highresponse rate to first-line chemotherapy, long-term survival is unusual, aspatients relapse and develop resistance to available agents.  Five-year survival is rare for patients withextensive-stage disease.

Topotecan(HycamtinÒ)is the only drug currently approved by the FDA for second-line therapy of SCLC.Topotecan is acamptothecin analogue that inhibits topoisomerase I, an enzyme involved in DNAreplication, transcription and recombination. Topotecan, however, is approved only forpatients with SCLCsensitive to platinum therapy, after a failurewith first-line chemotherapy.  Topotecan is used off-label inresistant/refractory SCLC.  At present,there are no FDA-approved therapies for patients withplatinum-resistant/refractory SCLC. Patients with SCLC who have resistant or refractory disease currentlyhave an extremely poor prognosis.  Forsingle agent therapy with topotecan, the overall response rate is 2—7%, andmedian survival is approximately 4.7 months. Based on clinical and preclinical data to date, we believe that NX 473has the potential to demonstrate activity in SCLC patients withplatinum-sensitive or resistant disease. A Phase II study was conducted by a prior licensee during 2000 and 2001to assess the activity and tolerability of the drug when given intravenously asa second-line therapy to patients with SCLC. Two of 13 patients (15.4%) withrefractory SCLC achieved a partial response (a decrease in the size of thetumor or in the extent of cancer in the body) with NX 473 treatment, and twoadditional patients (15.4%) achieved stable disease (no increase or decrease inextent or severity of the cancer). Overall, 4 of 13 patients (30.8%) with refractory SCLC achieved apartial response or stable disease with NX 473 treatment. The median survivalof all 13 treated patients was approximately 6.3 months, significantly longerthat that which would be expected with topotecan.

 

*Proposed NX 473 Study in Colorectal Cancer*

We also plan toundertake a Phase I/II trial of NX 473 in colorectal cancer. The proposed trialwould evaluate increasing doses of NX 473 in combination with the chemotherapyagents 5-fluorouracil  and leucovorin inpatients who have failed a 5-fluorouracil/leucovorin chemotherapy regimen.Endpoints would include safety, response rate (tumor shrinkage), duration ofresponse and time to progression.  Wecurrently are targeting this trial to begin in late 2005 or early 2006.

Preclinical dataindicates that NX 473 is active in colorectal cell lines sensitive or resistantto 5-fluorouracil, the most commonly used chemotherapeutic agent in first-linetreatment of CRC.

 

*NX 473Manufacture and Source of Supply*

We have a limitedsupply of NX 473 drug product that was manufactured by a prior licensee inSeptember 2004 and earlier.  The drugproduct has been demonstrated to be stable for 12-18 months from the date ofmanufacture, which time period is not sufficient to complete our proposedclinical trials of NX 473.  We will needto identify a new manufacturer of additional NX 473 drug product to completeour planned Phase II clinical trial in SCLC. If we are unable to demonstrateincreased stability or identify a new manufacturer for NX 473 on a timely andcommercially reasonable basis, we may be required to delay the clinical trialand the trial expenses may increase. There are a limited number of contractmanufacturers able to make drug products, such as NX 473.  We currently are in the process of identifyingpotential manufacturers of NX 473.  Thereis no assurance that we will be able engage a reliable manufacturer or toobtain sufficient supplies of NX 473 on a timely or cost-effective basis.

 

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# **Patents and Proprietary Rights**

 

Our policy is to aggressively protect our proprietarytechnologies.  We have filed applicationsfor US and foreign patents on many aspects of our technologies. We currentlyhave more than 100 issued US and foreign patents in our portfolio.

 

We hold an exclusive worldwide (except in Australia)license from The Dow Chemical Company for the development and commercial saleof STR.  Under that license, we aresolely responsible for the development and commercialization of STR.  Dow retains the obligation, at its cost, toprosecute patent applications and maintain, extend and defend all patents.  Dow also retains the first right to sue anythird party infringers of the STR patents. If Dow does not file suit, we have the right to sue the infringer at ourown expense.  Dow is entitled to certainpayments under the license if and when we receive final approval for commercialsale of STR in various jurisdictions. After final approval, Dow will be entitled to certain royalties andmilestone payments based on our annual net sales of STR and related products.If we are successful in achieving all milestones under the Dow agreement, ourtotal milestone payments to Dow would be $8.5 million.  We cannot be certain of the extent of oursuccess, if any, in commercializing STR and attaining established milestones.The license agreement may be terminated by either party for breach.  We can terminate the license at any time uponprior written notice to Dow.  Dow mayterminate the license if we cease to carry on our business as a result ofliquidation, bankruptcy or insolvency. If not earlier terminated, the license agreement will continue in effectuntil expiration of all patents licensed under the agreement.  We currently anticipate such expiration dateto be February 3, 2015.  Upon expirationof the Dow license agreement, we will retain from Dow a fully paid-up licenseto use unpatented technology related to STR. If Dow were to breach its obligations under the license, or if thelicense expires or is terminated and we cannot renew, replace, extend orpreserve our rights under the license agreement, our STR development effortsand our business could be significantly adversely affected.

 

Our STR portfolio includes US and foreign patents andapplications licensed from Dow and owned by NeoRx, covering the STR productcomposition and its use. With respect to our STR product in development in theUnited States, we currently rely primarily on US patent numbers USPN 4,882,142(expiring December 19, 2008) and USPN 5,059,412 (expiring October 22,2008), both of which are licensed to us by The Dow Chemical Company, and USPN6,767,531 issued to NeoRx (expiring June 12, 2020). Additional licensed patentsexpiring on November 21, 2009 and December 15, 2009, cover STR in the EuropeanUnion.  The patent protection andexclusivity afforded STR under the Dow license is further supplemented by theFDA’s designation of STR as an orphan drug for the treatment of multiplemyeloma.  Orphan drug status entitles STRto a seven-year exclusive marketing period for multiple myeloma in the UnitedStates following market approval.

 

We hold an exclusive worldwide (except Japan) licensegranted from AnorMED, Inc. for the development and commercial sale ofNX 473.  Under that license, we aresolely responsible for the development and commercialization of NX 473. AnorMEDretains the right to prosecute patent applications and maintain all licensedpatents, with NeoRx reimbursing such expenses. Under the AnorMED agreement, wehave the right to sue any third party infringers of the NX 473 patents in thelicensed territory (worldwide except Japan). If we do not file suit, AnorMED,in its sole discretion, has the right to sue the infringer at its expense. Theparties executed the license agreement in April 2004, at which time we paidAnorMED a one-time upfront milestone payment of $1.0 million in NeoRx commonstock and $1.0 million in cash.  Theagreement also provides for additional milestone payments to AnorMED of up to$13 million, payable in cash or a combination of cash and NeoRx common stock.These milestones include our successful completion of an NX 473 Phase II studyor initiation of an NX 473 Phase III study, submission to the FDA of anNDA for NX 473, regulatory approval from the FDA of NX 473 and theattainment of certain levels of annual net sales of NX 473.  Upon regulatory approval, AnorMED also wouldreceive royalty payments of up to 15% on product sales.  We cannot be certain of the extent of oursuccess, if any, in commercializing NX 473 and attaining established milestones.  The license agreement may be terminated byeither party for breach if the other party files a petition in bankruptcy orinsolvency or for reorganization or is dissolved, liquidated or makesassignment for the benefit of creditors. We can terminate the license at anytime upon prior written notice to AnorMED. If not earlier terminated, thelicense agreement will continue in effect, in each country in the territory inwhich the licensed product is sold or manufactured, until the earlier of (i)expiration of the last valid claim of a pending or issued patent covering thelicensed product in that country or (ii) a specified number of years afterfirst commercial sale of the licensed product in that country.

 

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Our NX 473 portfolioincludes US and foreign patents and applications licensed from AnorMED, whichcover the NX 473 product.  With respectto NX 473, we expect to rely primarily on US patent number 5,665,771 (expiring February7, 2016), which is licensed to us by AnorMED and additional licensed patentsexpiring in 2016, cover NX 473 in the European Union. To our knowledge, NX 473has not been designated as an orphan drug with respect to SCLC or any otherdisease.

 

A number of potential avenues exist which may furtherextend our STR and NX 473 patent protection and exclusivity.  In the United States, these include The DrugPrice and Competition and Patent Term Restoration Act of 1984, commonlyreferred to as the Hatch-Waxman Act, which, among other things, generallyprovides for patent term extension for up to five years for an issued patentcovering a drug product (or its use or manufacture) which has undergoneregulatory review before marketing.  Inaddition, since STR and NX 473 have not been previously approved for marketingin the United States, STR may qualify for new chemical entity data exclusivity,under which the FDA bans submissions of applications from competitors based onpublished data or Abbreviated New Drug Applications (ANDA) for a drugcontaining the same active agent. Certain patent term restoration proceduresand marketing exclusivity rights also may be available for qualifying drugproducts in the European Union or individual foreign countries.  We intend to evaluate the availability ofthese mechanisms for extending the patent term and marketing exclusivity forSTR and NX 473 on an individual regional or country basis if we conduct STRand/or NX 473 clinical trials abroad.  Wecannot be certain that we will be successful in any efforts to extend the termof any patent relating to STR or NX 473 or that STR or NX 473 will be granted marketing exclusivity rights inthe United States or abroad.

 

Risks associated with the protection of our patentsand other proprietary technologies are described under the heading “RiskFactors” above.  Pending or futureapplications of NeoRx or our collaborators will not necessarily result inissued patents.  Moreover, the currentpatents owned by or licensed to NeoRx may not provide substantial protection orcommercial benefit.  In addition topatent protection, we rely upon trade secrets, unpatented proprietary know-howand continuing technological innovation to develop and maintain our competitiveposition. Third parties could acquire or independently develop the same orsimilar technology, or our issued patents or those licensed could becircumvented, invalidated or rendered obsolete by new technology.  Third parties also could gain access to ordisclose our proprietary technology, and we may be unable to meaningfullyprotect our rights in such unpatented proprietary technology.

 

The rapid rate of development and the intense researchefforts throughout the world in biotechnology, the significant time lag betweenthe filing of a patent application and its review by appropriate authorities,and the lack of significant legal precedent involving biotechnology inventionsmake it difficult to predict accurately the breadth or degree of protectionthat patents will afford us or our licensees’ biotechnology products andunderlying technology.  It also isdifficult to predict whether valid patents will be granted based onbiotechnology patent applications or, if such patents are granted, to predictthe nature and scope of the claims of such patents or the extent to which theymay be enforceable.

 

Under United States law, although a patent has astatutory presumption of validity, the issuance of a patent is not conclusiveas to validity or as to the enforceable scope of its claims.  Accordingly, the patents owned or licensed byNeoRx could be infringed or designed around by third parties, and third partiescould obtain patents that we would need to license or design around.

 

### **Competition**

The competition fordevelopment of cancer therapies is substantial. There are numerous competitorsdeveloping products to treat the cancers for which we are seeking to developproducts. We initially are focusing clinical development of our STR productcandidate on the treatment of multiple myeloma. Several companies, includingCelgene Corp. and Millennium Pharmaceuticals, Inc., also are developing andtesting therapeutics for multiple myeloma. In May 2003, Millennium obtained FDA approval for its VelcadeTMtherapeutic for treatment of multiple myeloma patents who have received atleast two prior therapies and demonstrated disease progression on the lasttherapy.  Additionally, Quadramet®, a radiolabled bone-targeted therapy marketed by CytogenCorporation to relieve bone pain in patients with bone cancers, is beinginvestigated at higher doses in conjunction with high dose chemotherapy inmultiple myeloma.   Many biotechnologycompanies have corporate partnership arrangements with large, establishedcompanies to support research, development and 

 

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commercialization efforts of products that may becompetitive with our product candidates. Further, a number of established pharmaceutical companies, includingGlaxoSmithKline, Novartis AG and Bristol-Myers Squibb Co., are developingproprietary technologies or have enhanced their capabilities by entering intoarrangements with, or acquiring, companies with technologies applicable to thetreatment of cancer.  Many of ourexisting or potential competitors, have, or have access to, substantially greaterfinancial, research and development, marketing and production resources than wedo and may be better equipped than we are to develop, manufacture and marketcompeting products. Our competitors may have, or may develop and introduce, newproducts that would render our technology and proposed STR product lesscompetitive, uneconomical or obsolete by influencing the degree by whichtransplantation procedures are used to treat cancer patients.

 

The same competitive risks will apply to our efforts to develop NX 473and any other products.  Our initialfocus for NX 473 will be in small cell lung cancer, a disease for which therecurrently are limited effective therapeutic options. Numerous companies,including AstraZeneca PLC, Cell Therapeutics, Inc., Exelexis, Inc., ImCloneSystems Incorporated, ImmunoGen, Inc., Sanofi-Aventis Group, InexPharmaceuticals Corporation, Ipsen Limited, The Menarini Group, OSI Genetics,Inc. and PharmaMar USA, Inc., also are developing and testing therapeutics forsmall cell lung cancer. These therapeutics include chemotherapy, inhibitors,monoclonal antibodies, antagonists and interferons.  We cannot assure you that we will be able toeffectively compete with these or future third party product developmentprograms.

 

Timingof market introduction and healthcare reform, both uncertainties, will affectthe competitive position of our potential products. We believe that competitionamong products approved for sale will be based, among other things, on productsafety, efficacy, reliability, availability, third-party reimbursement, priceand patent protection.

**Government Regulation and Product Testing**

Themanufacture and marketing of our proposed STR and NX 473 products and ourresearch and development activities are subject to extensive regulation forsafety, efficacy and quality by numerous government authorities in the UnitedStates and other countries.  In theUnited States, drugs and biologics are subject to rigorous regulation by theFDA. The Federal Food, Drug and Cosmetic Act of 1976, as amended, theregulations promulgated thereunder, and other federal and state statutes andregulations govern, among other things, the testing, manufacture, safety,efficacy, labeling, storage, record keeping, approval, advertising andpromotion of STR or any other product candidate.  Product development and approval within thisregulatory framework take a number of years to accomplish, if at all, andinvolve the expenditure of substantial resources.

 The steps required before a pharmaceuticalproduct may be marketed in the United States include:

•                    preclinicallaboratory tests, *in vivo*preclinical studies andformulation studies;

•                    submission tothe FDA of an Investigational New Drug Application (IND), which must becomeeffective before clinical trials can commence;

•                    adequate andwell-controlled clinical trials to establish the safety and efficacy of thedrug;

•                    the submissionof a Biologic License Application (BLA) or New Drug Application (NDA) to theFDA; and

•                    FDA approvalof the BLA or NDA prior to any commercial sale or shipment of the drug.

Inaddition to obtaining FDA approval for each product, each domestic drugmanufacturing establishment must be registered with and inspected by theFDA.  Domestic manufacturingestablishments are subject to biennial inspections by the FDA and must complywith current Good Manufacturing Practice (cGMP) regulations, which are enforcedby the FDA through its facilities inspection program for biologics, drugs anddevices.  To supply products for use inthe United States, foreign manufacturing establishments must comply with cGMPregulations and are subject to periodic 

 

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inspection by the FDA orby corresponding regulatory agencies in such countries under reciprocalagreements with the FDA.

 

Preclinicalstudies include laboratory evaluation of product chemistry and formulation, aswell as animal studies, to assess the potential safety and efficacy of theproposed product.  Laboratories thatcomply with the FDA regulations regarding Good Laboratory Practice must conductpreclinical safety tests.  The results ofthe preclinical studies are submitted to the FDA as part of an IND and arereviewed by the FDA prior to commencement of clinical trials.  Unless the FDA provides comments to an IND,the IND will become effective 30 days following its receipt by the FDA.  Submission of an IND does not assure FDAauthorization to commence clinical trials.

Clinicaltrials involve the administration of the investigational new drug to healthyvolunteers or to patients under the supervision of a qualified principalinvestigator.  Clinical trials areconducted in accordance with the FDA’s Protection of Human Subjects regulationsand Good Clinical Practices under protocols that detail the objectives of thestudy, the parameters to be used to monitor safety and the efficacy criteria tobe evaluated. Each protocol must be submitted to the FDA as part of theIND.  Further, each clinical study mustbe conducted under the auspices of an independent Institutional Review Board(IRB) at the institution where the study will be conducted.  The IRB will consider, among other things,ethical factors, the safety of human subjects and the possible liability of theinstitution.

Clinicaltrials are typically conducted in three sequential Phases, but the Phases mayoverlap. In Phase I, the drug is tested for:

•                    safety(adverse effects);

•                    dosagetolerance;

•                    metabolism;

•                    distribution;

•                    excretion; and

•                    pharmaco-dynamics(clinical pharmacology).

In Phase II, a limitedpatient population is studied to:

•                    determine theefficacy of the drug for specific, targeted indications;

•                    determinedosage tolerance and optimal dosage; and

•                    identifypossible adverse effects and safety risks.

If acompound is found to have potential activity in a disease or condition and tohave an acceptable safety profile in Phase II clinical trials, Phase IIIclinical trials are undertaken to further evaluate clinical activity and tofurther test for safety within an expanded patient population at geographicallydispersed clinical study sites.  Often, PhaseIV (post-marketing) studies are required by the FDA in order to gain more dataon safety and efficacy with a drug after it has transitioned into generalmedical practice.  With respect to STR, NX473 or any proposed products subject to clinical trials, there can be noassurance that Phase I, Phase II or Phase III studies will be completedsuccessfully within any specific time period, if at all.  Clinical studies are inherently uncertain,and our Phase III trial of STR and our proposed NX 473 trials may not confirmthe results achieved in earlier clinical trials.  If STR or NX 473 is not shown to be safe andeffective, we will not be able to obtain the required regulatory approvals forcommercial sale of that product. Furthermore, we or the FDA may suspend clinical trials at any time if itis determined that the subjects or patients are being exposed to anunacceptable health risk.

The results of the pharmaceutical development, preclinical studies andclinical trials are submitted to the FDA in the form of a New Drug Application(NDA), for approval of the marketing and commercial shipment of the drug.  The testing and approval processes are likelyto require substantial cost, time and 

 

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effort, and there can be no assurance that any approval will be grantedon a timely basis, if at all.  The FDAmay deny an NDA if applicable regulatory criteria are not satisfied, mayrequire additional testing or information, or may require post-market testingand surveillance to monitor the safety of the product.  If regulatory approval is granted, suchapproval may entail limitations on the indicated uses for which the product maybe marketed.  The FDA may withdrawproduct approvals if compliance with regulatory standards is not maintained orif problems occur following initial marketing. Among the conditions for NDA approval is the requirement that theprospective manufacturers’ quality control and manufacturing procedures conformto cGMP regulations.  In complying withstandards set forth in these regulations, manufacturers must continue to expendtime, money and effort in the areas of production and quality control to ensurefull technical compliance.

**Employees**

As of March 17, 2005, we had 43 full-timeemployees and 4 part-time employees, which includes staff employed by ourmanufacturing subsidiary in Denton, TX.  Of these full-time employees, fivehold PhD degrees, one holds an MD degree, and one holds a JD degree.  Ofthe total full-time employees, 31 employees were engaged in research,development, or manufacturing activities and 12 were employed in generaladministration.  GeraldMcMahon, Ph.D. was appointed Chief Executive Officer of the Company, effectiveMay 11, 2004, and was named Chairman of the Board of Directors in June 2004. Hispredecessor, Jack L. Bowman, retired as Chief Executive Officer effective May11, 2004, and he did not stand for reelection as a director of the Company.  Melinda G. Kile resigned as Vice President,Finance, effective April 16, 2004, and Michael K. Jackson was promoted to ChiefAccounting Officer and assumed responsibility for senior financial duties on aninterim basis.  Susan D. Berland wasappointed Chief Financial Officer of the Company, effective October 25, 2004.The position of Chief Accounting Officer was eliminated as of December 31, 2004,and Mr. Jackson has resumed his prior responsibilities as Corporate Controller.

 

We consider our relations with employees to be good.None of our employees is covered by a collective bargaining agreement.

 

**Where YouCan Find More Information**

We file annual,quarterly and current reports, as well as registration and proxy statements andother information, with the Securities and Exchange Commission.  These documents may be read and copied at theSEC’s public reference rooms in Washington, DC, New York, NY and ChicagoIL.  Please call the SEC at1-800-SEC-0330 for further information on the public reference rooms.  Our SEC filings also are available to thepublic at the Internet website maintained by the SEC at www.sec.gov.  The Company’s reports filed with the SECafter January 1, 2003, also are available on our website, www.neorx.com.  The information contained in our website doesnot constitute part of, nor is it incorporated by reference into, this report.  We will provide paper copies of our SECfilings free of charge upon request.

 

***Item 2.  PROPERTIES***

 

We occupy approximately 21,000 square feet of officespace located at 300 Elliott Avenue West in Seattle, WA, under a lease thatexpires July 21, 2009.  In February 2003,the administrative offices previously located at 410 West Harrison Street,Seattle, WA, were consolidated into this location.

 

We continue to occupy approximately 2,900 square feetin a building and a parking area adjacent to the 410 West Harrison Streetbuilding.  In 2003, we made improvementsand converted 2,500 square feet of the space into a laboratory used for researchand development activities.  The balanceof the space is used for storage.  Thelease on this building expires on May 31, 2006.

In May 2004, we enteredinto a sublease for executive office space at 750 Battery St., San Francisco,CA.  We currently occupy two offices atthat location.  The lease ismonth-to-month and is terminable upon 30 days notice.

 

We believe that theforegoing facilities are in good condition and are adequate for all presentuses.

 

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In April 2001 we purchaseda radiopharmaceutical manufacturing facility located on 12 acres in Denton,TX.  The facility is operated inaccordance with current Good Manufacturing Practice (cGMP) and has been issuedappropriate radiation permits from the State of Texas. The main building isapproximately 88,000 square feet and houses approximately 12,000 square feet ofclean rooms.  The area has been used forradiopharmaceutical manufacturing, quality control laboratories and supportfunctions.  Current capabilities includeterminal sterilization, aseptic processing and aseptic filling ofradiopharmaceuticals, as well as STR formulation and filling.  The facility was designed to allow for futureexpansion.  In December 2003, we sold toTrace Radiochemical, Inc., certain unused real estate and associated equipmentadjacent to our Denton facility for $950,000. In connection with the sale, we also transferred to Trace our interestunder a lease of a cyclotron housed on the property.   We used the proceeds from the transaction toreduce our long-term debt on the facility.

We believe that theDenton facility has the capabilities and capacity to serve as our principalmanufacturing site for the STR compound for our Phase III trial.

 

***Item3.   LEGAL PROCEEDINGS***

 

Not Applicable.

 

***Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS***

 

Not Applicable.

 

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**PART II**

 

***Item 5.  MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS***

 

Our common stocktraded on The Nasdaq National Market System until March 20, 2003, when itslisting was transferred to The Nasdaq SmallCap Market. The following table setsforth, for the periods indicated, the high and low sales prices for our common stockas reported on The Nasdaq SmallCap Market. These quotations reflect inter-dealer prices without retail mark-up,markdown or commission, and may not necessarily represent actual transactions.

 

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2004**       |       |     |       |    |       |
| First Quarter  |       | $        | 5.78       |    | $          | 3.60 |   |
| Second Quarter |       | 4.12     |       | 2.37    |       |
| Third Quarter  |       | 2.66     |       | 1.43    |       |
| Fourth Quarter |       | 2.51     |       | 1.43    |       |
| **2003**       |       |     |       |    |       |
| First Quarter  |       | $        | 0.82       |    | $          | 0.37 |   |
| Second Quarter |       | 3.60     |       | 0.70    |       |
| Third Quarter  |       | 6.28     |       | 2.34    |       |
| Fourth Quarter |       | 6.47     |       | 4.10    |       |

 

The closing priceof our common stock on The Nasdaq SmallCap Market was $1.26 on March 17, 2005.

 

There wereapproximately 948 shareholders of record as of March 17, 2005.  This figure does not include the number ofshareholders whose shares are held on record by a broker or clearing agency,but includes such a brokerage house or clearing agency as one holder of record.

 

We have not paidany cash dividends on our common stock since our inception and do not intend topay cash dividends on our common stock in the foreseeable future.

 

On March 7, 2005, weraised approximately $3.9 million in net proceeds through the sale in a privateplacement under Section 4(2) of the Securities Act of 1933, as amended, of 3,320,000shares of common stock to selected institutional investors at a price of $1.25per share.  In addition, purchasers ofthe common stock received five-year warrants to purchase an aggregate of 1,328,000shares of common stock at $2.00 per share. The warrants do not becomeexercisable until September 3, 2005.   The shares of common stock sold in theoffering have not been registered under the Securities Act and cannot beoffered or sold in the United States absent registration or an applicableexemption from registration.  As part ofthe transaction, we agreed to file a registration statement covering resale ofthe shares of common stock issued in the financing and issuable upon exerciseof the warrants. Rodman & Renshaw LLC served as the placement agent in theoffering.  For their services asplacement agent, we paid Rodman & Renshaw a cash fee of $249,000 and issuedthem a warrant to purchase 199,200 shares of common stock.  The warrant issued to Rodman & Renshaw ison the same terms as the warrants granted to the purchasers in the offering.

 

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***Item 6.  SELECTEDFINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)***

 

The followingtable shows selected financial data.  Itis important to read this selected financial data along with the “FinancialStatements and Supplementary Data,” as well as “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”

 
| ** **                                                         | ** ** | **Years Ended  December 31,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                         | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Consolidated Statement of Operations Data:**                     |       |                          |       |   |   |   |   |   |   |   |   |
| Revenues                                                           |       | $                             | 1,015      |   | $ | 10,531 |   | $ | 11,054 |   | $ | 2,873 |   | $ | 3,549 |   |
| Operating expenses                                                 |       | 20,502                        |       | 15,218 |   | 34,949 |   | 29,020 |   | 21,594 |   |
| Loss from operations                                               |       | (19,487                       | )          | (4,687 | ) | (23,895 | ) | (26,147 | ) | (18,045 | ) |
| Net loss                                                           |       | (19,371                       | )          | (5,059 | ) | (23,093 | ) | (23,802 | ) | (11,402 | ) |
| Net loss applicable to common shareholders                         |       | (19,871                       | )          | (7,535 | ) | (23,593 | ) | (24,303 | ) | (11,905 | ) |
| Net loss per common share — basic and diluted                 |       | $                             | (0.66      | ) | $ | (0.28 | ) | $ | (0.89 | ) | $ | (0.92 | ) | $ | (0.50 | ) |
| Weighted average common shares outstanding— basic and diluted |       | 30,143                        |       | 27,280 |   | 26,645 |   | 26,402 |   | 23,853 |   |
| **Consolidated Balance Sheet Data:**                               |       |                          |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                          |       | $                             | 16,254     |   | $ | 15,166 |   | $ | 6,564 |   | $ | 4,097 |   | $ | 8,389 |   |
| Investment securities                                              |       | 1,499                         |       | 12,335 |   | 9,572 |   | 29,484 |   | 49,189 |   |
| Working capital                                                    |       | 15,689                        |       | 26,064 |   | 14,195 |   | 31,123 |   | 59,315 |   |
| Total assets                                                       |       | 27,436                        |       | 35,691 |   | 25,993 |   | 51,028 |   | 64,458 |   |
| Note payable, net of current portion                               |       | 3,905                         |       | 4,112 |   | 5,182 |   | 5,696 |   | — |   |
| Shareholders’ equity                                          |       | $                             | 20,828     |   | $ | 29,490 |   | $ | 17,576 |   | $ | 41,715 |   | $ | 62,245 |   |

 

 

***Item 7.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS***

 

#### **Introduction**

 

The followingdiscussion of results of operations, liquidity and capital resources containsforward-looking statements that involve risks and uncertainties.  As described in the “Important InformationRegarding Forward-Looking Statements” at the beginning of this report, ouractual results may differ materially from the results discussed in theforward-looking statements.  Factors thatmight cause or contribute to such differences include those discussed below andin the section entitled “Risk Factors.”

 

#### **CriticalAccounting Policies**

 

*Basis of Revenue Recognition:*Todate, we do not have any significant ongoing revenue sources.  On occasion, we derive significant revenuefrom the sale or licensing of our patented technologies and from governmentgrants.  Pursuant to the Securities andExchange Commission Staff Accounting Bulletin No. 104 (SAB 104) and EmergingIssues Task Force Consensus No. 00-21, revenues from collaborative agreementsare recognized as earned as we perform research activities under the terms ofeach agreement.  Billings in excess ofamounts earned are classified as deferred revenue.  To the extent that a transaction containsmultiple deliverables, we determine whether the multiple deliverables areseparable, and, if separable, the revenue to be allocated to each deliverablebased on fair value.  If fair value isundeterminable for undelivered elements of the arrangement, revenue is deferredover the contract period or until delivery, as applicable.  The revenue allocated to each deliverable isrecognized following the requirements of SAB 104.  For a detailed description of our revenuerecognition policy, refer to Note 2, Summary of Significant AccountingPolicies, of the Notes to the Consolidated Financial Statements.

 

*Impairment of Long-Lived Assets:*Asof December 31, 2004, we had approximately $7.1 million of property andequipment. In accounting for these long-lived assets, we make estimates aboutthe expected useful lives of the assets, the expected residual values of theassets, and the potential for impairment based on events or circumstances. Theevents or circumstances could include a significant decrease in market value, asignificant change in asset condition or a significant adverse change inregulatory climate.  Application of thetest for impairment requires judgment.

 

In September 2002, we recognized a non-cash assetimpairment loss of $5.6 million on certain facilities and equipment resultingfrom our decisions to reduce 

 

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staff at our Denton, TX radiopharmaceutical manufacturing facility,eliminate contract manufacturing activities in Denton, and curtail Pretargetactivities at our Seattle, WA research and development facility. The loss onthe Denton facility and related equipment was determined via outsideappraisals.  The loss on the equipment atthe Seattle facility was determined via estimates of potential sales values ofused equipment.  An additional impairmentcharge of $0.6 million relating to intangible assets for licenses and processesat the Denton facility was recorded in the fourth quarter of 2002. The fourthquarter impairment charge was associated with our decision to suspendproduction of the STR compound and operate the Denton facility on a standbybasis, pending a decision to resume clinical testing of STR and production ofclinical materials.

 

*Long Term Debt:*  We assumed our note payable to Texas StateBank in connection with the acquisition of our radiopharmaceuticalmanufacturing facility in Denton, TX. The assets acquired secure the note payable.  The terms of the loan provide that an eventof default may be deemed to occur if the Company abandons, vacates or discontinuesoperations on a substantial portion of the Denton facility or there is amaterial adverse change in its operations. If this were to occur, Texas StateBank could declare the entire outstanding amount of the loan ($4.2 million atDecember 31, 2004) due and immediately payable. In our judgment we do not believe that a material adverse change in ouroperations has occurred that would cause Texas State Bank to accelerate theloan.  Accordingly we believe thatclassification as long term of that portion of the note that is due for paymentin 2006 and thereafter is proper.

 

*Stock Compensation:*  We currently measure compensation cost usingthe intrinsic value-based method of accounting for stock options granted toemployees and disclose the impact of the fair value method in the footnotes tothe consolidated financial statements. In December 2004, the FinancialAccounting Standards Board issued a revised Statement of Financial AccountingStandards No. 123, “Share Based Payment,” which requires that fair value berecorded in the results of operations beginning no later than July 1, 2005.Since there is no market for trading employee stock options, there is nocertainty that the result of the fair value method would be the value at whichemployee stock options would be traded for cash. Fair value methods requireseveral assumptions, the most significant of which are stock price volatilityand the average life of an option. See New Accounting Pronouncements below foradditional information.

 

#### **Results ofOperations**

 

***Year Ended December 31, 2004 Compared with December31, 2003***

 

Our revenues for 2004 totaled $1.0 million, which primarilyconsisted of milestone payments from Boston Scientific Corporation.  Our revenues for 2003 totaled $10.5 million,which primarily consisted of $10.0 million from the assignment and licensing toBoston Scientific Corporation of certain intellectual property and revenue froma facilities lease.

Total operating expenses increased 35% to $20.5 million for theyear ended December 31, 2004, from $15.2 million for the same period in 2003.

Research and development expenses for the year ended December 31,2004 increased 39% to $13.3 million, from $9.6 million for the same period in2003.  Among the primary components ofthe increase were a  $4.0 million inincreased costs related to the STR Phase III trial, which was opened in March2004, and a $0.6 million increase in pre-clinical development costs related toNX 473, offset by a $0.2 million decrease resulting from the curtailment of ourPretarget program in July 2002.

General and administrative expenses increased 14% to $7.2 millionfor the year ended December 31, 2004, from $6.3 million for the same period in2003.  The increase in G&A costs forthe year ended December 31, 2004 was due primarily to an increase of $0.6 millionfor personnel related costs and $0.3 million for increased accounting fees.

In February 2004, we raised approximately $9.0 million in grossproceeds through the sale in a private placement of 1,845,000 shares of common stock.  The purchasers in that offering also receivedfive-year warrants to purchase an aggregate of 922,500 shares of common stockat $7.00 per share.  As payment ofplacement agent fees for that financing, we issued three-year warrants topurchase 35,000 shares of common stock at an exercise price of $5.54 pershare.  We recorded a charge to  general and administrative expense of $118,000for the fair value of the warrants on February 23, 2004.

In April 2004, weacquired from AnorMED, Inc. the worldwide exclusive rights, excluding Japan, todevelop, manufacture and commercialize NX 473, a platinum-based anti-canceragent.  Under the terms of the agreement,we paid AnorMED a one-time upfront milestone payment of $1.0 million in ourcommon stock and $1.0 million in cash.

Other income totaled $0.1 million in 2004 and consisted primarilyof interest income of $0.3 million, offset by interest expense of $0.2million.  Other expenses totaled $0.2million in 2003 and consisted primarily of realized loss on the sale ofinvestment securities.

In March 2004, theCompany entered into a contract with the University of Missouri ResearchReactor facility group (MURR) located in Columbia, Missouri, under which MURRis responsible for the manufacture, including process qualification, qualitycontrol, packaging and shipping, of the holmium-166 component of STR for theCompany’s STR Phase III trial.  InNovember 2004, the Company exercised its option to extend the term of theagreement until March 1, 2006. Under the contract, the Company pays a fixedprice per unit of holmium-166 ordered, subject to a minimum purchaserequirement, and fixed amounts for handling and maintenance.  During 2004 the Company purchased the minimumquantities under the contract, which totaled approximately $510,000.  Minimum purchases during 2005 under thecontract are estimated to be approximately $630,000.

Preferreddividends on Series 1 Preferred Stock were $0.5 million in both 2004 and 2003.

 

***Year Ended December 31, 2003 Compared with December31, 2002***

 

Our revenues for2003 totaled $10.5 million, which consisted of $10.0 million from theassignment and licensing to Boston Scientific Corporation of certainintellectual property and revenue from a facilities lease.  Our revenues for 2002 totaled $11.1 million,which consisted of $7.9 million from the sale to IDEC PharmaceuticalsCorporation of certain intellectual property and the grant to IDEC of certainlicense and option rights,milestone payments of $2 million from Angiotech Pharmaceuticals, Inc., andrevenue from government grants and a facilities lease.

 

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Total operating expenses decreased 56% to $15.2 million for theyear ended December 31, 2003, from $34.9 million for the same time period in2002.  Total operating expenses for theyear ended December 31, 2002 included a non-cash asset impairment charge of$6.2 million. Additionally, a restructuring charge of $1.2 million was incurredin 2002 relating to severance for reductions in staff.

Research and development expenses decreased 54% to $9.6 millionfor the year ended December 31, 2003, from $20.8 million for the same timeperiod in 2002.  The decrease in researchand development expenses for the year ended December 31, 2003, predominatelywas due to an overall reduction of all research and development activities,including a $5.5 million decrease in our STR product development program and a$4.0 million decrease resulting from the curtailment of our PretargetÒ clinical development programs inJuly 2002.

General and administrative expenses decreased 7% to $6.3 millionfor the year ended December 31, 2003, from $6.8 million for the same timeperiod in 2002.  The decrease in generaland administrative costs for the year ended December 31, 2003 was due toreductions of $0.3 million in facilities expense, $0.2 million in recruitingcosts and $0.2 million in corporate communications expense, partially offset byincreases of $0.2 million in compensation costs and $0.1 million in insuranceexpense.

During the year 2003, we recorded a $0.2 million cumulative effectof change in accounting principle as a result of our adoption of SFAS 143,Accounting for Asset Retirement Obligations, effective January 1, 2003.  In December 2003 we sold certain real estateand associated equipment located adjacent to our Denton, TX manufacturing facilityto Trace Radiochemical, Inc., for $950,000. In connection with the sale, wealso transferred our interest under a lease of a cyclotron that is housed onthe property.  The transfer of theseassets eliminated the future asset retirement obligation as recorded under SFAS143.

In December 2003, we raised approximately $15.75 million in grossproceeds through the sale in a private placement of 1,575 shares of a newlycreated class of Series B Convertible Preferred Stock.  The purchasers in that offering also receivedfive-year warrants to purchase an aggregate of 630,000 shares of common stockat $6.00 per share.  We recognized abeneficial conversion feature in determining net loss applicable to commonshares of $2.0 million for the value associated with the warrants issued inconnection with the Series B preferred stock.

Other expenses totaled $0.2 million in 2003 and consistedprimarily of realized loss on the sale of investment securities.  Other income totaled $0.8 million in 2002 andconsisted primarily of interest income from investment securities.

Preferreddividends on Series 1 Preferred Stock were $0.5 million in both 2003 and 2002.

 

 

***Major Research and Development Projects***

Our major research and development projects during the fiscalyears ended December 31, 2004, 2003 and 2002 were Skeletal Targeted Radiotherapy (STRTM) andPretarget® technology.

**Skeletal Targeted Radiotherapy.**  We are developing STR for the treatment ofmultiple myeloma, a cancer originating in the bone marrow.  STR is designed to deliver radiationspecifically to sites of cancer in the bone and bone marrow.  STR consists of a bone-seeking moleculecalled DOTMP, which deposits the radioactive substance, holmium-166, in theskeleton.  We have incurred costs of approximately $55.4 millionin connection with the STR program since the program’s inception in 1998.

In October 2003, we reached agreement with the FDA on our STRPhase III clinical trial design. This agreement, called a Special ProtocolAssessment, establishes the number of patients to be studied and how and whenthe drug’s safety and effectiveness will be determined. At the same time, theFDA confirmed that a single Phase III trial is sufficient to obtain marketingapproval for STR, provided that the drug is shown to be safe and effective inthe trial.  Although the FDA has agreed to accept completeresponse as a surrogate endpoint for efficacy in the Phase III trial, we arerequired to follow the Phase III patients for survival as our Phase IVcommitment.

 

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We opened the Phase IIItrial of STR to patient enrollment in March 2004. We have prioritized the listof prospective clinical sites according to their readiness, experience andprojected rate of patient accrual, and are working to open them on a rollingbasis. There are presently 20 clinical sites open and we plan to have as manyas 40 clinical sites participating in the trial.  Initial patient accrual in our Phase IIItrial has progressed more slowly than expected. There are a very limited numberof patients with primary refractory myeloma who will be qualified forenrollment in our Phase III clinical trial, and that number may become morelimited if emerging therapies are more effective than existing therapies. Wehave undertaken a number of measures, including a substantial patient and communityoncologist outreach program, designed to make referring physicians and patientsmore aware of STR and the Phase III trial. We also are working with the FDA to amend the eligibility criteria forour trial as a means of potentially increasing enrollment.  We may not be able to enroll enough qualifiedpatients to complete the clinical trial in a timely manner, or at all. We donot plan to announce the opening of clinical sites or the enrollment ofpatients.  We anticipate that the STRPhase III trial will take several years to complete, and we do not expect tosubmit a New Drug Application (NDA) for the potential approval of STR to theFDA before 2008. The actual timing of filing an NDA, if at all, will bedependent upon our ability to open clinical sites and enroll qualified patientsinto the trial, our ability to obtain additional capital to fund the trial, ourability to manufacture the STR compound and distribute it to the clinical siteson a timely basis, and actions by the clinical institutions, the FDA and otherregulatory agencies. If our enrollment outreach efforts are not successful orother factors outlined above adversely affect our efforts, the date of oursubmission of an NDA may be substantially delayed

Total estimatedcosts to complete the STR clinical trial and potentially obtain marketingapproval are in the range of $35-40 million, including cost of clinical drugsupply.  These costs could besubstantially higher if we have to repeat, revise or expand the scope of ourtrials, or conduct additional clinical trials not presently planned, to securemarketing approvals.

Material cashinflows relating to our STR development will not commence until after marketingapprovals are obtained, if they are obtained, and then only if STR finds acceptancein the marketplace. To date, we have not received any revenues from productsales of STR.

The risks anduncertainties associated with completing the development of STR on schedule, orat all, include the following, as well the other risk factors described in thisreport:

•                    STR may not beshown to be safe and efficacious in the Phase III trials;

•                    We may beunable to obtain regulatory approval of the drug or may be unable to obtainsuch approval on a timely basis;

•                    We may beunable to continue to manufacture or otherwise secure adequate supplies of STRin order to complete the Phase III clinical trial and initiate commerciallaunch upon approval;

•                    We may beunable to open clinical sites and recruit enough patients to complete the PhaseIII trial in a timely manner; and

•                    We may nothave adequate funds to complete the development of STR.

If we fail to obtain marketing approval for STR, areunable to secure adequate clinical and commercial supplies of STR, or do notcomplete development and obtain regulatory approval on a timely basis, ouroperations, financial position and liquidity could be severely impaired,including as follows:

 

•                    We would notearn any sales revenue from STR, which would increase the likelihood that wewould need to obtain additional financing for our other development efforts;and

•                    Our reputationamong investors might be harmed, which could make it more difficult for us toobtain equity capital on attractive terms or at all.

Because of the many risks and uncertainties relatingto the completion of clinical trials, receipt of marketing approvals andacceptance in the marketplace, we cannot predict the period in which materialcash inflows from our STR program will commence, if ever.

 

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**Pretarget*. ***Pretarget technology is a developmentplatform for targeted immunotherapeutics that deliver intense doses ofanti-cancer agents to tumor cells, while largely sparing healthy tissues.  We curtailed our Pretarget productdevelopment activities in July 2002.  Thediscontinued Pretarget activities included our Pretarget Lymphoma and PretargetCarcinoma Phase I/II clinical programs and manufacturing development activitiesassociated with the Pretarget programs. We  sold our Pretarget technologyto Aletheon Pharmaceuticals, Inc. in April 2004.

We cannotdetermine the total costs incurred for the Pretarget program.  The Pretarget program was initiated in 1987,and records separately tracking the costs of the project over its approximately15-year history are not readily available.*** ***Due to our decision todiscontinue the Pretarget program, there is neither an anticipated completiondate nor an expected period during which material net cash inflows willcommence.  Following our restructuring in2002, we have not depended on the successful development and completion of ourPretarget technology and, therefore, there are no risks and uncertaintiesassociated with the Pretarget program that would materially impact ouroperations and financial position.  InApril 2004, we sold our Pretarget technology to Aletheon PharmaceuticalsInc.   We received no upfrontconsideration in connection with the sale, but could receive up to $6.6 millionin milestone payments, as well as royalties, if Aletheon is successful in itstechnology development program.

Our developmentadministration overhead costs, consisting of rent, utilities, consulting fees,patent costs and other various overhead costs, are included in total researchand development expense for each period, but are not allocated among ourvarious projects.  Finally, our totaldevelopment costs include the costs of various other research efforts directedtoward the identification and evaluation of future product candidates.  These other research projects, which includeour proposed NX 473 program, are pre-clinical and not considered majorprojects.  Our total research anddevelopment costs are summarized below:

 

 

**Summary of Research andDevelopment Costs**

 

| ** **                            | ** ** | **2004**           | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                            | ** ** | **(in thousands)** | ** ** |
| STR                                   |       | $                  | 10,155     |     | $          | 6,169    |       | $ | 11,665 |   |
| NX 473                                |       | 555                |       | —   |       | —   |       |
| Pretarget                             |       | 72                 |       | 240      |       | 4,220    |       |
| Other overhead  and research costs    |       | 2,549              |       | 3,182    |       | 4,941    |       |
|                                  |       |               |       |     |       |     |       |
| Total research  and development costs |       | $                  | 13,331     |     | $          | 9,591    |       | $ | 20,826 |   |
|                                  |       |               |       |     |       |     |       |

 

 

***Liquidity and Capital Resources***

 

We have financed ouroperations primarily through the sale of equity securities, technologylicensing, collaborative agreements and debt instruments.  We invest excess cash in investmentsecurities that will be used to fund future operating costs.  Cash, cash equivalents and investmentsecurities totaled $17.8 million at December 31, 2004 compared to $27.5 millionat December 31, 2003.  We primarily fundcurrent operations with our existing cash and investments.  Cash used by operating activities for the twelve months endedDecember 31, 2004 totaled $17.5 million.** **Revenues and other income sourcesfor 2004 were not sufficient to cover operating expenses.

We raised approximately $3.9 million in net proceeds fromthe sale of common stock and warrants in a private placement transaction inMarch 2005.  We intend to use the netproceeds from this financing added to our existing funds to support our PhaseIII trial in STR, to initiate a Phase II trial in NX 473 in small cell lungcancer and for general working capital.  General and administrative expenses in 2004increased 14% over the same period in 2003, due primarily to increases inpersonnel related costs and increased accounting fees.  These costsincluded such actions as the hiring of additional personnel in 

 

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senior management as wellas compliance with the requirements of Sarbanes-Oxley.  We expect G&Aexpenses to increase at levels consistent with support of Company operationsand regulatory compliance, but at a slower rate of increase than expensesassociated with clinical trials and other core operational activities.  With the proceeds of this offering, webelieve that our present cash, cash equivalents, investment securities andexpected interest income will be sufficient to fund our anticipated workingcapital and capital requirements at least through the fourth quarter of2005.  In the event that sufficientadditional funds are not obtained in the future, we may be required to delay,reduce or curtail the scope of our STR and NX 473 development programs,including any clinical trials, and other product development efforts and/orfurther reduce costs for facilities and administration.

In April 2003, wereceived $10 million from the sale to Boston Scientific Corporation (BSC) ofcertain non-core patents and patent applications and the grant to BSC ofexclusive license rights to certain patents and patent applications.  BSC originally asserted four such patents intwo lawsuits against Johnson & Johnson, Inc. and certain of itssubsidiaries, including Cordis Corporation and Guidant Corporation, alleginginfringement of such patents.** **In both lawsuits, the defendantsdenied infringement and asserted invalidity and unenforceability of thepatents.  Boston subsequently withdrewthree of the patents from the litigation. Although we are not currently a party to the lawsuits, our managementand counsel have been deposed in connection with the lawsuits.  It is possible that BSC, if it isunsuccessful or has limited success with its claims against Johnson &Johnson, Inc. and its subsidiaries, may seek damages from us, includingrecovery of all or a portion of the amounts it paid to us in 2003.  We cannot assess the likelihood of whethersuch claim will be brought against us or the extent of recovery, if any, on anysuch claim.

 

In December 2003,we raised approximately $14.6 million in net proceeds through the sale in aprivate placement of shares of a newly created class of Series B ConvertiblePreferred Stock, which are convertible, on an as adjusted basis, at a price of$4.57 per share, into  3,446,389 sharesof common stock, and warrants to purchase an aggregate of 630,000 common sharesat $6.00 per share.  Additionally, weraised approximately $9.0 million in net proceeds from the sale of common stockand warrants in a private placement transaction in February 2004.

In connection withour 2001 purchase of the radiopharmaceutical manufacturing plant and otherassets located in Denton, TX, we assumed $6.0 million principal amount ofrestructured debt held by Texas State Bank, McAllen, TX.  The loan, which matures in April 2009, issecured by the assets acquired in the transaction.  The interest rate on the loan was 5.25% onDecember 31, 2004.  The interest rate isequal to the bank prime rate and adjusts on the same date that the bank primerate changes.  The loan provides for amaximum annual interest rate of 18%. Principal and interest are payable in monthly installments. Principaland interest paid on the note during the years ended December 31, 2004 totaled$486,000.  In December 2003, we solda non-essential portion of our Denton facility, the proceeds of which($827,000) were applied to reduce the outstanding balance on the loan. As ofDecember 31, 2004, the outstanding balance of the loan was $4.2 million. Thefixed monthly payments on the note are recalculated in April of each year basedon the then current bank prime interest rate and outstanding note balance. Thebank prime interest rate of 4.00% was in effect on the payment recalculationdate in April 2004.  Because the loan isamortized over a fourteen-year period from its inception, a principal balancewill remain at maturity in April 2009. Based on an interest rate of 5.25%, the estimated principal balancepayable at maturity would be $2.75 million.

The terms of theTexas State Bank loan provide that an event of default may be deemed to occurif we abandon, vacate or discontinue operations on a substantial portion of theDenton facility or there is a material adverse change in our operations. Ifthis were to occur, Texas State Bank could declare the entire outstandingamount of the loan ($4.2 million at December 31, 2004) due and immediatelypayable. In such case, our cash resources and assets could be impaireddepending on our ability to raise funds through a sale of the Denton facilityand other means.  Based on aNovember 2002 appraisal of the Denton facility, the fair value of thefacility and its assets exceeds the amount of the outstanding debt.  We do not believe that there has been anymaterial adverse change in our operations that would cause Texas State Bank toaccelerate the loan or that would affect our ability to continue to makerequired payments under the loan.

In April 2004, we acquired from AnorMED, Inc. theworldwide exclusive rights, excluding Japan, to develop, manufacture andcommercialize NX 473, a platinum-based anti-cancer agent.  Under the terms of the agreement, we paidAnorMED a one-time upfront milestone payment of $1.0 million in our commonstock and $1.0 million in cash.  Theagreement also provides for additional milestone payments to AnorMED 

 

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of up to $13 million, payable in cash or a combination of cash and ourcommon stock.  Upon regulatory approval,AnorMED would receive royalty payments of up to 15% on product sales.  Given that the earliest a Phase II studycould commence, as stated below, is mid-2005, it is unlikely that these milestoneswould be triggered during 2005 or 2006. Since we cannot predict the length of time to complete the first PhaseII study, when we would commence a Phase III study or when we might submit anNDA for NX 473, we are unable to predict when such milestones might betriggered after 2006.  We filed an INDapplication for NX 473 in October 2004 for a Phase II study in small cell lungcancer and currently plan to initiate the trial in mid—2005.  We also currently plan to initiate a study ofNX 473 in patients with colorectal cancer in late 2005 or early 2006.  We have a limited supply of the NX 473 drugcompound.  We will need to identify a newmanufacturer of additional NX 473 drug product to complete our planned clinicaltrials. There is no assurance that we will be able to engage a reliablemanufacturer or obtain sufficient supplies of NX 473 on a timely orcost-effective basis.

Also in April 2004, we sold and transferred ourPretarget intellectual property to Aletheon Pharmaceuticals, Inc.  Under the agreement, we could receive up to$6.6 million in milestone payments if Aletheon achieves certain developmentgoals, plus royalties on potential future product sales.  We did not receive any upfront considerationfor the sale of the Pretarget property. We discontinued our clinical studies using the Pretarget technology inJuly 2002, and since that time, had been actively seeking, both throughtargeted inquiries and a broad-based auction process, a buyer or licensee forthe technology.  The sale of thePretarget intellectual property relieves us of the annual costs associated withmaintaining the Pretarget patent estate. During 2003, we spent approximately $350,000 for the prosecution andmaintenance of the Pretarget patents and trademarks.  For 2004, these costs were approximately$70,000.  Seattle-based Aletheon is adevelopment stage biotherapeutics company founded by two former NeoRxemployees.  The timing and amount ofmilestone payments, if any, are uncertain. The terms of the transaction were determined through arms-lengthnegotiation.  Neither the Company nor BayCity Capital LLC and its affiliates at any time has held, or in the futureplans to acquire, a financial interest in Aletheon.

We have historicallysuffered recurring operating losses and negative cash flows fromoperations.  As of February 28, 2005, wehad net working capital of $12.6 million and had an accumulated deficit of$237.6 million with total shareholders’ equity of $17.6 million.  Our consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States, assuming that we will continue as a going concern.

 

While management believesthat current cash and cash equivalent balances, and any net cash provided byoperations, may provide adequate resources to fund operations at least untilDecember 31, 2005, this may not be the case. Management is therefore exploring a number of alternatives to enable usto continue operating, including:

 

•                    raisingadditional capital to fund continuing operations by private placements or othersales of equity or debt securities or through the establishment of otherfunding facilities;

 

•                    enteringinto strategic collaborations, which may include joint ventures or partnershipsfor product development and commercialization, merger, sale of assets or othersimilar transactions; and

 

•                    obtainingadditional capital resources to fund operations through cost cuttingmechanisms, including the delay, reduction or curtailment of our current andplanned STR and NX 473 development programs.

 

We have no assurance thatany of these alternatives will be successful. We may not be able to obtain the required additional capital or enterinto relationships with corporate partners on a timely basis, on favorableterms, or at all.  Conditions in thecapital markets in general, and the life science capital market specifically,may affect our potential financing sources and opportunities for strategicpartnering.  If we are unable to obtainsufficient cash when needed to fund our operations, we may be forced to seek protectionfrom creditors under the bankruptcy laws.

 

Our actual capitalrequirements will depend upon numerous factors, including:

 

•               therate of progress and costs of our STR clinical trials and research anddevelopment activities, including our ability to activate clinical sites andenroll qualified patients into our STR Phase III clinical trial;

 

•               ourability to obtain clinical material from third-party suppliers and manufactureSTR in a timely and cost-effective manner;

 

•               actionstaken by the FDA and other regulatory authorities;

 

•               thescope and timing of our proposed NX 473 clinical program and other research anddevelopment efforts;

 

•               theacquisition or in-licensing of other products or intellectual property, if wechoose to undertake such activities;

 

•               thecosts of discontinuing projects and technologies or decommissioning existingfacilities, if we undertake those activities;

 

 

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•               thetiming and amount of any milestone or other payments we might receive fromexisting and potential strategic partners and licensees;

 

•               ourdegree of success in commercializing STR, NX 473 or any other cancer therapyproduct candidates;

 

•               theemergence of competing technologies and products, and other adverse market developments;and

 

•               thecosts of preparing, filing, prosecuting, maintaining and enforcing patentclaims and other intellectual property rights.

 

Our financial statements are prepared on a going concern basis;however, our inability to obtain additional cash as needed could have amaterial adverse effect on our financial position, results of operations andour ability to continue in existence. Our consolidated financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.

At December 31,2004, the Company had the following long-term commitments (in thousands):
| ** **           | ** ** | **Less than 1 year** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------|------------|----------------------|------------|---------------|------------|---------------|------------|----------------|------------|-----------|------------|
| Lease commitments    |       | $                    | 652        |          | $          | 1,188         |       | $              | 869        |      | $          | — |   | $ | 2,709 |   |
| Note payable (1)     |       | $                    | 516        |          | $          | 1,068         |       | $              | 3,421      |      | $          | — |   | $ | 5,005 | (2) |
| Purchase commitments |       | $                    | 630        |          | $          | 165           |       | $              | —     |      | $          | — |   | $ | 795 |   |

 

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(1)  Amounts include interest payments.

(2)  Amount includes total principal payment of$4,207 as reflected on the Consolidated Balance Sheet for the year ended December 31, 2004.

 

**NewAccounting Pronouncements**

 

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards(SFAS) No.123R, Share-Based Payment. SFAS 123R replaces SFAS 123,Stock-Based Compensation, issued in 1995. SFAS 123R requires that the fairvalue of the grant of employee stock options be reported as an expense in the results of operationsbeginning no later than July 1, 2005.  Historically, the Company has disclosed inits footnotes the pro forma expense effect of the grants.  Stockcompensation expense under the prior rules would have increased reporteddiluted loss per share by $0.04 in 2004. Upon adoption of the revised standard, prior awards will be charged toexpense under the prior rules, and awards after adoption will be charged toexpense under the revised rules.  TheCompany has not determined the effect of the new standard on itsearnings; however, expense under the new standard could be higher. The effectof adopting the new rules on reported diluted earnings per share is dependenton the number of options granted in the future, the terms of those awards, andtheir fair values and, therefore, the effect on diluted earnings per sharecould change.  The Company expects toadopt the revised rules on July 1, 2005, but has not determined whether itwill adopt prospectively or retrospectively to January 1, 2005. See Note 2to the Notes to the Consolidated Financial Statements for assumptions used bymanagement in calculating the fair value of employee stock options.  The adoption of the Statement is expected tohave a material effect on the financial statements.

***Item 7A.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK***

 

                TheCompany is exposed to the impact of interest rate changes and changes in themarket values of its investments.

 

 

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**InterestRate Risk**

 

The Company’s exposure to market rate risk for changesin interest rates relates primarily to the Company’s debt securities includedin its investment portfolio.  The Companydoes not have any derivative financial instruments.  The Company invests in debt instruments ofthe US Government and its agencies and high-quality corporate issuers.  Investments in both fixed rate and floatingrate interest earning instruments carry a degree of interest rate risk.  Fixed rate securities may have their fairmarket value adversely impacted due to an increase in interest rates, whilefloating rate securities may produce less income than expected if interestrates decrease.  Due in part to thesefactors, the Company’s future investment income may fall short of expectationsdue to changes in interest rates or the Company may suffer losses in principalif forced to sell securities that have declined in market value due to changesin interest rates.  At December 31, 2004,the Company owned a federal government debt instrument amounting to $1.5million that matures during the first quarter of 2005 and owned no corporate debtsecurities. The Company’s exposure to losses as a result of interest ratechanges is managed through investing primarily in securities with relativelyshort maturities of up to one year and securities with variable interest rates.

 

The Company’s only outstanding debt is its notepayable to Texas State Bank.  Theoutstanding balance of the note was $4.2 million on December 31, 2004.  The note, which matures in April 2009, bearsinterest equal to the bank prime rate. The interest rate on the note is recalculated in April of eachyear.  The maximum permitted interestrate on the loan is 18% per annum. Because the interest rate on the note variesannually, the Company’s interest expenses may increase as the bank primeinterest rate increases.  Extreme increasesin the bank prime interest rate, up to the maximum interest rate permittedunder the note, could materially affect the Company’s interest expense.

 

**InvestmentRisk**

 

The Company hasreceived equity instruments under licensing agreements.  These instruments are included in investmentsecurities and are accounted for at fair value with unrealized gains and lossesreported as a component of comprehensive loss and classified as accumulatedother comprehensive income — unrealized gain on investment securities inshareholders’ equity.  Such investmentsare subject to significant fluctuations in fair market value due to thevolatility of the stock market.  InJanuary 2002, all of the corporate equity securities were sold and the Companyrecognized a net gain on the sale of approximately $109,000.   At December 31, 2004, the Company owned nosuch corporate equity securities.

 

40

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*** ***

***Item 8.  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA***

 
| ** **                                                                                                                                | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Reports  of Independent Registered Public Accounting Firm                                                                                 |       |
| Consolidated Balance  Sheets — December 31, 2004 and 2003                                                                            |       |
| Consolidated  Statements of Operations — For the Years Ended December 31, 2004, 2003 and  2002                                       |       |
| Consolidated  Statements of Shareholders’ Equity and Comprehensive Loss — For the Years  Ended December 31, 2004, 2003 and 2002 |       |
| Consolidated  Statements of Cash Flows — For the Years Ended December 31, 2004, 2003 and  2002                                       |       |
| Notes to  Consolidated Financial Statements                                                                                               |       |

 

 

 

All financial schedules are omitted since the requiredinformation is not applicable or has been presented in the financial statementsand the notes thereto.

 

41

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**Report of Independent RegisteredPublic Accounting Firm**

 

The Board of Directorsand Shareholders

NeoRx Corporation:

 

We have auditedthe accompanying consolidated balance sheets of NeoRx Corporation andSubsidiaries as of December 31, 2004 and 2003, and the related consolidatedstatements of operations, shareholders’ equity and comprehensive loss, and cashflows for each of the years in the three-year period ended December 31, 2004.These consolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted ouraudits in accordance with the standards of the Public Company AccountingOversight Board (United States).  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of NeoRx Corporation and Subsidiariesas of December 31, 2004 and 2003, and the results of their operations and cashflows for each of the years in the three-year period ended December 31, 2004,in conformity with U.S. generally accepted accounting principles.

 

We also haveaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the effectiveness of NeoRx Corporationinternal control over financial reporting as of December 31, 2004, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO), andour report dated March 28, 2005 expressed an unqualified opinion on management’sassessment of, and the effective operation of, internal control over financialreporting.

 

The accompanyingconsolidated financial statements have been prepared assuming that the Companywill continue as a going concern. As discussed in Note 1 to the consolidatedfinancial statements, the Company has suffered recurring losses, has hadsignificant recurring negative cash flows from operations, and has anaccumulated deficit that raise substantial doubt about its ability to continueas a going concern. Management’s plans in regard to these matters are alsodescribed in Note 1. The consolidated financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 
| KPMG LLP            |   |
|---------------------|--------|
|                |
| Seattle, Washington |
| March 28, 2005      |

 

42

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# **Reportof Independent Registered Public Accounting Firm**

 

The Board of Directors and Shareholders

NeoRx Corporation:

 

We have auditedmanagement’s assessment, included in the accompanying Management’s Assessmentof Internal Controls, that NeoRx Corporation maintained effective internalcontrol over financial reporting as of December 31, 2004, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO). NeoRx Corporation’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

 

We conducted ouraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

A company’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control over financial reporting includes thosepolicies and procedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

Because of itsinherent limitations, internal control over financial reporting may not preventor detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

In our opinion,management’s assessment that NeoRx Corporation maintained effective internalcontrol over financial reporting as of December 31, 2004, is fairly stated, inall material respects, based on criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Also, in our opinion, NeoRxCorporation maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2004, based on criteria establishedin Internal Control—

 

43

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Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).

 

We also haveaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheets of NeoRxCorporation as of December 31, 2004 and 2003, and the related consolidatedstatements of operations, shareholders’ equity and comprehensive loss, and cashflows for each of the years in the three-year period ended December 31, 2004,and our report dated March 28, 2005 expressed an unqualified opinion.  Our report dated March 28, 2005 contains anexplanatory paragraph that states that the company has suffered recurringlosses, has had significant recurring negative cash flows from operations, andhas an accumulated deficit that raise substantial doubt about its ability tocontinue as a going concern.  Theconsolidated financial statements do not include any adjustments that mightresult from the outcome of that uncertainty. On those consolidated financialstatements.

 

 
| KPMG LLP            |   |
|---------------------|--------|
|                |
|                |
| Seattle, Washington |
| March 28, 2005      |

 

44

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**NEORX CORPORATION AND SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS**

**(In thousands, except share data)**

 

 
| ** **                                                                                                                                                                      | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **2004**         | ** ** | **2003** | ** ** |
| **ASSETS******                                                                                                                                                                  | ** ** |
| **Current  assets:**                                                                                                                                                            |       |             |       |   |   |
| Cash and cash  equivalents                                                                                                                                                      |       | $                | 16,254     |   | $ | 15,166 |   |
| Investment  securities                                                                                                                                                          |       | 1,499            |       | 12,335 |   |
| Prepaid expenses  and other current assets                                                                                                                                      |       | 638              |       | 652 |   |
| Total current  assets                                                                                                                                                           |       | 18,392           |       | 28,153 |   |
| **Facilities  and equipment, at cost:**                                                                                                                                         |       |             |       |   |   |
| Land                                                                                                                                                                            |       | 345              |       | 345 |   |
| Building                                                                                                                                                                        |       | 5,779            |       | 5,237 |   |
| Leasehold  improvements                                                                                                                                                         |       | 49               |       | 49 |   |
| Equipment and  furniture                                                                                                                                                        |       | 3,122            |       | 3,162 |   |
| Construction in  progress                                                                                                                                                       |       | —           |       | 310 |   |
|                                                                                                                                                                            |       | 9,295            |       | 9,103 |   |
| Less:  accumulated depreciation and amortization                                                                                                                                |       | (2,193           | )          | (1,632 | ) |
| Facilities and  equipment, net                                                                                                                                                  |       | 7,102            |       | 7,471 |   |
| Other assets                                                                                                                                                                    |       | 67               |       | 67 |   |
| Licensed  product, net of accumulated amortization of $125                                                                                                                      |       | 1,875            |       | — |   |
| **Total  assets**                                                                                                                                                               |       | $                | 27,436     |   | $ | 35,691 |   |
|                                                                                                                                                                            |       |             |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                  |
| **Current  liabilities:**                                                                                                                                                       |       |             |       |   |   |
| Accounts payable                                                                                                                                                                |       | $                | 1,130      |   | $ | 409 |   |
| Accrued  liabilities                                                                                                                                                            |       | 1,271            |       | 1,295 |   |
| Current portion  of note payable                                                                                                                                                |       | 302              |       | 385 |   |
| Total current  liabilities                                                                                                                                                      |       | 2,703            |       | 2,089 |   |
| **Long-term  liabilities:**                                                                                                                                                     |       |             |       |   |   |
| Note payable,  net of current portion                                                                                                                                           |       | 3,905            |       | 4,112 |   |
| Total long-term  liabilities                                                                                                                                                    |       | 3,905            |       | 4,112 |   |
| **Shareholders’  equity:**                                                                                                                                                 |       |             |       |   |   |
| Preferred stock,  $.02 par value, 3,000,000 shares authorized:                                                                                                                  |       |             |       |   |   |
| Convertible  preferred stock, Series 1, 205,340 shares issued and outstanding at December  31, 2004 and 2003 (entitled in liquidation to $5,175 at December 31, 2004 and  2003) |       | 4                |       | 4 |   |
| Convertible  preferred stock, Series B, 1,575 shares issued and outstanding at December  31, 2004 and 2003 (entitled in liquidation to $15,750)                                 |       | —           |       | — |   |
| Common stock,  $.02 par value, 60,000,000 shares authorized, 30,908,753 and 28,002,945  shares issued and outstanding, at December 31, 2004 and 2003, respectively              |       | 618              |       | 560 |   |
| Additional  paid-in capital                                                                                                                                                     |       | 254,510          |       | 243,365 |   |
| Accumulated  deficit, including other comprehensive loss of $1 and $7 at December 31, 2004  and 2003, respectively                                                              |       | (234,304         | )          | (214,439 | ) |
| Total  shareholders’ equity                                                                                                                                                |       | 20,828           |       | 29,490 |   |
| **Total  liabilities and shareholders’ equity**                                                                                                                            |       | $                | 27,436     |   | $ | 35,691 |   |
|                                                                                                                                                                            |       |             |       |   |   |
| See accompanying notes  to the consolidated financial statements.                                                                                                               |

 

45

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**NEORX CORPORATON AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

**(In thousands, except per sharedata)**

 
| ** **                                                                                                                | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Revenues******                                                                                                          |       | $                            | 1,015      |   | $ | 10,531 |   | $ | 11,054 |   |
| **Operating  expenses:**                                                                                                  |       |                         |       |   |   |   |   |
| Research and  development                                                                                                 |       | 13,331                       |       | 9,591 |   | 20,826 |   |
| General and  administrative                                                                                               |       | 7,171                        |       | 6,265 |   | 6,752 |   |
| Gain on sale of  real estate and equipment                                                                                |       | —                       |       | (638 | ) | — |   |
| Asset impairment  loss                                                                                                    |       | —                       |       | — |   | 6,216 |   |
| Restructuring                                                                                                             |       | —                       |       | — |   | 1,155 |   |
| Total operating  expenses                                                                                                 |       | 20,502                       |       | 15,218 |   | 34,949 |   |
| Loss from  operations                                                                                                     |       | (19,487                      | )          | (4,687 | ) | (23,895 | ) |
| **Other  income (expense):**                                                                                              |       |                         |       |   |   |   |   |
| Realized (loss)  gain on sale of securities                                                                               |       | —                       |       | (151 | ) | 160 |   |
| Interest income                                                                                                           |       | 326                          |       | 198 |   | 975 |   |
| Interest expense                                                                                                          |       | (210                         | )          | (229 | ) | (333 | ) |
| Total other  income (expense)                                                                                             |       | 116                          |       | (182 | ) | 802 |   |
| Net loss before  cumulative effect of change in accounting principle                                                      |       | (19,371                      | )          | (4,869 | ) | (23,093 | ) |
| Cumulative  effect of change in accounting principle                                                                      |       | —                       |       | (190 | ) | — |   |
| Net loss                                                                                                                  |       | (19,371                      | )          | (5,059 | ) | (23,093 | ) |
| Preferred stock,  Series B warrants beneficial conversion feature                                                         |       | —                       |       | (1,976 | ) | — |   |
| Preferred stock  dividends                                                                                                |       | (500                         | )          | (500 | ) | (500 | ) |
| Net loss  applicable to common shares                                                                                     |       | $                            | (19,871    | ) | $ | (7,535 | ) | $ | (23,593 | ) |
|                                                                                                                      |       |                         |       |   |   |   |   |
| Loss per share:                                                                                                           |       |                         |       |   |   |   |   |
| Basic and  diluted loss per share applicable to common shares before cumulative effect  of change in accounting principle |       | $                            | (0.66      | ) | $ | (0.27 | ) | $ | (0.89 | ) |
| Cumulative  effect of change in accounting principle                                                                      |       | —                       |       | (0.01 | ) | — |   |
| Basic and  diluted loss applicable to common shares                                                                       |       | $                            | (0.66      | ) | $ | (0.28 | ) | $ | (0.89 | ) |
| Weighted average  common shares outstanding — basic and diluted                                                      |       | 30,143                       |       | 27,280 |   | 26,645 |   |
|                                                                                                                      |       |                         |       |   |   |   |   |
| Pro forma  amounts had accounting principle been applied retroactively:                                                   |       |                         |       |   |   |   |   |
| Net loss                                                                                                                  |       |                         |       |   |   | $ | (23,205 | ) |
| Preferred stock  dividends                                                                                                |       |                         |       |   |   | (500 | ) |
| Loss applicable  to common shares                                                                                         |       |                         |       |   |   | $ | (23,705 | ) |
| Loss per share:                                                                                                           |       |                         |       |   |   |   |   |
| Basic and diluted                                                                                                         |       |                         |       |   |   | $ | (0.89 | ) |
|  

See accompanying notes  to the consolidated financial statements.                                                 |

 

46

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**NEORX CORPORATION ANDSUBSIDIARY**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’EQUITY**

**AND COMPREHENSIVE LOSS**

**(In thousands)**

 

| ** **                                                             | ** ** | **Preferred Stock, Series 1** | ** ** | **Preferred Stock, Series B** | ** ** | **Common Stock**     | ** ** | ** **    | ** ** | ** **           | ** ** | ** **    | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|----------------------|------------|---------------|------------|----------------------|------------|---------------|------------|
| ** **                                                             | ** ** | **Number of Shares**          | ** ** | **Par Value**                 | ** ** | **Number of Shares** | ** ** | **Par Value** | ** ** | **Number of Shares** | ** ** | **Par Value** | ** ** | **Additional Paid-In Capital** | ** ** | **Accumulated Deficit** | ** ** | **Share-holder’s Equity** | ** ** |
| ** **                                                             | ** ** | ** **                    | ** ** | ** **                    | ** ** | ** **           | ** ** | ** **    | ** ** | ** **           | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balance, December 31, 2001**                                         |       | 205                           |       | $                             | 4          |                 | —     |          | $          | —               |       | 26,571        |       | $ | 532 |   | $ | 223,905 |   | $ | (182,726 | ) | $ | 41,715 |   |
| Common stock issued for services                                       |       | —                        |       | —                        |       | —               |       | —        |       | 150                  |       | 2             |       | 65 |   | — |   | 67 |   |
| Exercise of stock options and warrants                                 |       | —                        |       | —                        |       | —               |       | —        |       | 44                   |       | 1             |       | 20 |   | — |   | 21 |   |
| Stock options and warrants issued for services                         |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | 45 |   | — |   | 45 |   |
| Comprehensive loss:                                                    |       |                          |       |                          |       |                 |       |          |       |                 |       |          |       |   |   |   |   |   |   |
| Net loss                                                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (23,093 | ) | (23,093 | ) |
| Unrealized loss on investment securities                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (519 | ) | (519 | ) |
| Less: reclassification adjustment for net gain on sales of  securities |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (160 | ) | (160 | ) |
| Total comprehensive loss                                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (23,772 | ) | (23,772 | ) |
| Preferred stock dividends                                              |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (500 | ) | (500 | ) |
| **Balance, December 31, 2002**                                         |       | 205                           |       | 4                             |       | —               |       | —        |       | 26,765               |       | 535           |       | 224,035 |   | (206,998 | ) | 17,576 |   |
| Common stock issued for services                                       |       | —                        |       | —                        |       | —               |       | —        |       | 80                   |       | 2             |       | 35 |   | — |   | 37 |   |
| Exercise of stock options and warrants                                 |       | —                        |       | —                        |       | —               |       | —        |       | 1,158                |       | 23            |       | 1,849 |   | — |   | 1,872 |   |
| Modification of outstanding employee options                           |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | 590 |   | — |   | 590 |   |
| Stock options issued for services                                      |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | 269 |   | — |   | 269 |   |
| Preferred stock and warrants issued, net of offering costs of  $1,139  |       | —                        |       | —                        |       | 2                    |       | —        |       | —               |       | —        |       | 14,611 |   | — |   | 14,611 |   |
| Comprehensive loss:                                                    |       |                          |       |                          |       |                 |       |          |       |                 |       |          |       |   |   |   |   |   |   |
| Net loss                                                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (5,059 | ) | (5,059 | ) |
| Unrealized loss on investment securities                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (57 | ) | (57 | ) |
| Less: reclassification adjustment for net loss on sales of  securities |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | 151 |   | 151 |   |
| Total comprehensive loss                                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (4,965 | ) | (4,965 | ) |
| Beneficial conversion feature, Series B preferred stock                |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | 1,976 |   | (1,976 | ) | — |   |
| Preferred stock dividends                                              |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (500 | ) | (500 | ) |
| **Balance, December 31, 2003**                                         |       | 205                           |       | $                             | 4          |                 | 2          |          | $          | —               |       | 28,003        |       | $ | 560 |   | $ | 243,365 |   | $ | (214,439 | ) | $ | 29,490 |   |
| Exercise of stock options and warrants                                 |       | —                        |       | —                        |       | —               |       | —        |       | 817                  |       | 16            |       | 784 |   | — |   | 800 |   |
| Common stock issued for licensed product                               |       | —                        |       | —                        |       | —               |       | —        |       | 244                  |       | 5             |       | 995 |   |   |   | 1,000 |   |
| Common stock issued, net of offering costs of $763                     |       | —                        |       | —                        |       | —               |       | —        |       | 1,845                |       | 37            |       | 9,005 |   |   |   | 9,042 |   |
| Modification of outstanding employee options                           |       | —                        |       | —                        |       |                 |       |          |       |                 |       |          |       | 340 |   |   |   | 340 |   |
| Stock options issued for services                                      |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | 21 |   | — |   | 21 |   |
| Comprehensive loss:                                                    |       |                          |       |                          |       |                 |       |          |       |                 |       |          |       |   |   |   |   |   |   |
| Net loss                                                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (19,371 | ) | (19,371 | ) |
| Unrealized gain on investment securities                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | 6 |   | 6 |   |
| Total comprehensive loss                                               |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (19,365 | ) | (19,365 | ) |
| Preferred stock dividends                                              |       | —                        |       | —                        |       | —               |       | —        |       | —               |       | —        |       | — |   | (500 | ) | (500 | ) |
| **Balance, December 31, 2004**                                         |       | 205                           |       | $                             | 4          |                 | 2          |          | $          | —               |       | 30,909        |       | $ | 618 |   | $ | 254,510 |   | $ | (234,304 | ) | $ | 20,828 |   |
|                                                                   |       |                          |       |                          |       |                 |       |          |       |                 |       |          |       |   |   |   |   |   |   |

 

Seeaccompanying notes to the consolidated financial statements.

 

47

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**NEORX CORPORATION ANDSUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 

| ** **                                                                   | ** ** | **Years Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Cash flows from operating activities:**                                    |       |                          |       |   |   |   |   |
| Net loss                                                                     |       | $                             | (19,371    | ) | $ | (5,059 | ) | $ | (23,093 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |       |                          |       |   |   |   |   |
| Depreciation and amortization                                                |       | 800                           |       | 793 |   | 1,751 |   |
| Loss (gain) on sale of securities                                            |       | —                        |       | 151 |   | (160 | ) |
| Loss on disposal of equipment                                                |       | 20                            |       | 240 |   | 77 |   |
| Gain on sale of real estate and equipment                                    |       | —                        |       | (638 | ) | — |   |
| Asset impairment loss                                                        |       | —                        |       | — |   | 6,216 |   |
| Restructuring                                                                |       | —                        |       | — |   | 1,155 |   |
| Cumulative effect of change in accounting principle                          |       | —                        |       | 190 |   | — |   |
| Accretion of asset retirement obligation liability                           |       | —                        |       | 62 |   | — |   |
| Common stock issued for services                                             |       | —                        |       | 4 |   | 67 |   |
| Stock options and warrants issued for services                               |       | 21                            |       | 269 |   | 45 |   |
| Stock-based employee compensation                                            |       | 340                           |       | 590 |   | — |   |
| Change in operating assets and liabilities:                                  |       |                          |       |   |   |   |   |
| Prepaid expenses and other assets                                            |       | 13                            |       | 243 |   | 228 |   |
| Accounts payable                                                             |       | 721                           |       | 80 |   | (513 | ) |
| Accrued liabilities                                                          |       | (24                           | )          | (991 | ) | (1,182 | ) |
| Net cash used in operating activities                                        |       | (17,480                       | )          | (4,066 | ) | (15,409 | ) |
|                                                                         |       |                          |       |   |   |   |   |
| **Cash flows from investing activities:**                                    |       |                          |       |   |   |   |   |
| Proceeds from sales and maturities of investment securities                  |       | 10,875                        |       | 25,588 |   | 49,516 |   |
| Purchases of investment securities                                           |       | (33                           | )          | (28,408 | ) | (30,123 | ) |
| Facilities and equipment purchases                                           |       | (326                          | )          | (365 | ) | (682 | ) |
| Purchase of licensed product                                                 |       | (1,000                        | )          | — |   | — |   |
| Proceeds from sales of equipment and facilities                              |       | —                        |       | 1,049 |   | — |   |
| Net cash provided by (used in) investing activities                          |       | 9,516                         |       | (2,136 | ) | 18,711 |   |
|                                                                         |       |                          |       |   |   |   |   |
| **Cash flows from financing activities:**                                    |       |                          |       |   |   |   |   |
| Repayment of capital lease obligations                                       |       | —                        |       | (50 | ) | (50 | ) |
| Receipt of note receivable principal                                         |       | —                        |       | 68 |   | — |   |
| Repayment of bank note payable principal                                     |       | (290                          | )          | (1,197 | ) | (306 | ) |
| Proceeds from stock options and warrants exercised                           |       | 800                           |       | 1,872 |   | 21 |   |
| Preferred stock dividends                                                    |       | (500                          | )          | (500 | ) | (500 | ) |
| Proceeds from issuance of common stock and warrants                          |       | 9,042                         |       | 14,611 |   | — |   |
| Net cash provided by (used in) financing activities                          |       | 9,052                         |       | 14,804 |   | (835 | ) |
| Net increase in cash and cash equivalents                                    |       | 1,088                         |       | 8,602 |   | 2,467 |   |
|                                                                         |       |                          |       |   |   |   |   |
| **Cash and cash equivalents:**                                               |       |                          |       |   |   |   |   |
| Beginning of year                                                            |       | 15,166                        |       | 6,564 |   | 4,097 |   |
| End of year                                                                  |       | $                             | 16,254     |   | $ | 15,166 |   | $ | 6,564 |   |
|                                                                         |       |                          |       |   |   |   |   |
| **Supplemental disclosure of non-cash financing  activity:**                 |       |                          |       |   |   |   |   |
| Purchase of Licensed Products with common stock                              |       | $                             | 1,000      |   | $ | — |   | $ | — |   |
| Accrual of preferred dividend                                                |       | 500                           |       | 500 |   | 500 |   |
| Beneficial conversion feature, Series B preferred stock                      |       | —                        |       | 1,976 |   | — |   |
| Surrender of common stock to exercise options                                |       | —                        |       | 94 |   | — |   |
| Issuance of common stock to settle accrued bonuses                           |       | —                        |       | 33 |   | — |   |
| **Supplemental disclosure of cash paid during the  period for:**             |       |                          |       |   |   |   |   |
| Cash paid for interest                                                       |       | $                             | 196        |   | $ | 232 |   | $ | 334 |   |

See accompanying notes to the consolidatedfinancial statements.

*** ***

***48***

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***NEORXCORPORATION AND SUBSIDIARY***

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

 

***NOTE 1.   Organizationand Operations***

 

NeoRx is a biotechnologycompany dedicated to the development and commercialization of  cancer therapy products. Theconsolidated financial statements include the accounts of NeoRx Corporation andits wholly owned subsidiary, NeoRx Manufacturing Group (Company).

 

The Company has historically suffered recurringoperating losses and negative cash flows from operations.  As of February 28, 2005, the Company had networking capital of $12.6 million and had an accumulated deficit of $237.6 millionwith total shareholders’ equity of $17.6 million.  These consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States, assuming that the Company will continue as a going concern.

 

While management believes that current cash and cashequivalent balances, and any net cash provided by operations, may provideadequate resources to fund operations at least until December 31, 2005, thismay not be the case.  Management istherefore exploring a number of alternatives to enable the Company to continueoperating including, but not limited to:

 

•       raising additional capital to fund continuing operations byprivate placements or other sales of equity or debt securities or through theestablishment of other funding facilities;

 

•       entering into strategic collaborations, which may includejoint ventures or partnerships for product development and commercialization,merger, sale of assets or other similar transactions; and

 

•       obtaining additional capital resources to fund operationsthrough cost cutting mechanisms, including the delay, reduction or curtailmentof the Company’s current and planned STR and NX 473 development programs.

 

The Company’s inability to obtain additional cash asneeded could have a material adverse effect on its financial position, resultsof operations and its ability to continue in existence. These consolidatedfinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

 

All inter-company balances and transactions have beeneliminated.

 

***NOTE 2.  Summary of Significant Accounting Policies***

 

*Estimates and Uncertainties*:  The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

*Research and Development Revenues and Expenses*:  Revenues from collaborative agreements arerecognized as earned as the Company performs research activities under theterms of each agreement. Billings in excess of amounts earned are classified asdeferred revenue. Pursuant to the Securities and Exchange Commission StaffAccounting Bulletin No. 104, also known as SAB 104, “Revenue Recognition inFinancial Statements,” non-refundable upfront technology license fees, wherethe Company is providing continuing services related to product development,are deferred.  Such fees are recognizedas revenue over the product development periods based on estimated totaldevelopment costs.  If the Company is notproviding continuing services, revenue is recognized when the payment is due.

 

To date, the Company does not have any significantongoing revenue sources.  Pursuant to the Securities and ExchangeCommission Staff Accounting Bulletin No. 104, “Revenue Recognition,” (SAB 104)and Emerging Issues Task Force Consensus No. 00-21, “Revenue Arrangements withMultiple Deliverables,” (EITF 00-21), which became effective for revenuearrangements entered into in fiscal periods beginning after June 15, 2003,revenues from sales and licensing of intellectual property and governmentgrants are recognized as earned. To the extent that a transaction containsmultiple deliverables, the Company determines whether the multiple deliverablesare separable, and, if separable, the revenue to be allocated to eachdeliverable based on fair value. If fair value is undeterminable forundelivered elements of the arrangement, revenue is deferred over the contractperiod or until delivery, as applicable. The revenue allocated to eachdeliverable is recognized following the requirements of SAB 104.

 

Specifically, the Company’s revenue in the periodspresented consisted primarily of the sale and licensing of intellectualproperty, milestone payments received, and receipt of government grants. Forthe sale and licensing of intellectual property and milestone payments, revenuehas been recognized as payments are due as the Company has not had continuingservice or other obligations subsequent to the sale, licensing or milestonepayment.  Additionally, milestonepayments are based on events that represent the achievement of substantivesteps in the development process and are believed to represent the fair valueof achieving the milestone.  Governmentgrant revenue is recognized as earned based on completion of performance underthe respective contracts whereby no ongoing obligation on the part of theCompany exists.  Milestone payments arerecognized as revenue at the time such payments are due, based on the ratio ofcumulative costs incurred to date, to total estimated development costs.  Any remaining balance is deferred andrecognized as revenue over the remaining development period

 

Research and development costs are expensed asincurred.  It is the Company’s practiceto offset third-party collaborative reimbursements received as a reduction ofresearch and development expenses. Third-party reimbursements for 2004, 2003, and 2002 were $259,000,$149,000, and $134,000, respectively.

 

*Cash Equivalents*:  All highly liquid investments with anoriginal maturity of three months or less when purchased are considered to becash equivalents.  Cash equivalents representcash invested primarily in money

 

49

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market funds, federal government and agency securities and corporatedebt securities.

 

*Investment Securities:*  The Company considers all investmentsecurities as available-for-sale.  Allsecurities are carried at fair value. The Company does not invest in derivative financial instruments.  Unrealized gains and losses on investmentsecurities are reported as a component of comprehensive income or loss andclassified as accumulated other comprehensive income or loss - unrealized gain(loss) on investment securities in shareholders’ equity.  The Company monitors investment securitiesfor other than temporary declines in fair value and charges impairment lossesto income when an other than temporary decline in estimated value occurs.

 

*Facilities andEquipment*:  Facilities and equipment are stated atcost.  Depreciation is provided using thestraight-line method over estimated useful lives of five to seven years forequipment and furniture, three years for computer equipment and software andthirty years for buildings.  Leaseholdimprovements are amortized using the straight-line method over the shorter ofthe assets’ estimated useful lives or the terms of the leases.

 

*Impairment ofLong-Lived Assets:*Long-lived assets including property and equipment are reviewed for possibleimpairment whenever significant events or changes in circumstances, includingchanges in our business strategy and plans, indicate that an impairment mayhave occurred. An impairment is indicated when the sum of the expected futureundiscounted net cash flows identifiable to that asset or asset group is lessthan its carrying value. Impairment losses are determined from actual orestimated fair values, which are based on market values, net realizable valuesor projections of discounted net cash flows, as appropriate.

 

*Licensed Products*: Licensed Products represent an exclusive license to develop, manufactureand commercialize NX 473, a platinum-based anti-cancer agent.  Licensed Products are amortized using thestraight-line method over their estimated useful life of twelve years.  The Company evaluates the recoverability ofLicensed Products periodically and takes into account events or circumstancesthat might indicate that an impairment exists. No impairment of Licensed Products was identified during 2004.

 

*Income Taxes*:  The Company computes income taxes using theasset and liability method, under which deferred income taxes are provided forthe temporary differences between the financial reporting basis and the taxbasis of the Company’s assets and liabilities and for operating loss and taxcredit carry forwards.  A valuationallowance is established when necessary to reduce deferred tax assets to theamount, if any, which is expected more likely than not to be realized.

 

*Net Loss Per CommonShare*:  Basic and diluted loss per share are based onnet loss applicable to common shares, which is comprised of net loss,beneficial conversion feature and preferred stock dividends in all periodspresented. Shares used to calculate basic loss per share are based on theweighted average number of common shares outstanding during the period.  Shares used to calculate diluted loss pershare are based on the potential dilution that would occur upon the exercise orconversion of securities into Common Stock using the treasury stockmethod.  The computation of diluted netloss per share excludes the following options and warrants to acquire shares ofCommon Stock for the years indicated because their effect would not bedilutive.

 

| ** **            | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-----------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Common Stock options  |       | 3,528,000  |       | 4,103,000  |       | 4,495,000  |       |
| Common Stock warrants |       | 1,588,000  |       | 1,505,000  |       | 890,000    |       |

 

Additionally234,088 aggregate shares issuable upon conversion of the Company’s PreferredStock Series 1 are not included in the calculation of diluted loss per sharefor 2002 because the share increments would not be dilutive.  Aggregate shares of 3,446,390 and 234,088issuable as of 

 

50

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December 31, 2004 uponconversion of the Company’s Preferred Stock Series B and Series 1,respectively, are not included in the calculation of diluted loss per share for2004 and 2003 because the share increments would not be dilutive.

 

*Stock OptionPlans: *The Company accounts for its stockoption plans for employees in accordance with the provisions of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations, including FASB Interpretation No. 44, Accounting forCertain Transactions Involving Stock Compensation, an interpretation of APBOpinion No. 25.  Compensation expenserelated to employee stock options is recorded if, on the date of grant, thefair value of the underlying stock exceeds the exercise price.  The Company applies the disclosure-onlyrequirements of SFAS No. 123, “Accounting for Stock-Based Compensation” andSFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure, an amendment of FASB Statement No. 123,” which allows entities tocontinue to apply the provisions of APB Opinion No. 25 for transactions withemployees and to provide pro forma results of operations disclosures foremployee stock option grants as if the fair-value based method of accounting inSFAS No. 123 had been applied to these transactions.  Stock compensation costs related to fixedemployee awards with pro rata vesting are recognized on a straight-line basisover the period of benefit, generally the vesting period of the options.  For options and warrants issued tonon-employees, the Company recognizes stock compensation costs utilizing thefair value methodology prescribed in SFAS No. 123 over the related period ofbenefit.

 

Had compensationcost for these stock option plans been determined using the fair value basedmethod of accounting under SFAS 123, “Accounting for Stock-Based Compensation,”the Company’s net loss applicable to common shares and net loss per share wouldhave been the pro forma amounts indicated below (in thousands, except per sharedata):

 
| ** **                                                                                         | ** ** | **Year ended December  31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                         | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss applicable to common shares:                                                              |       |                         |       |   |   |   |   |
| As reported                                                                                        |       | $                            | (19,871    | ) | $ | (7,535 | ) | $ | (23,593 | ) |
| Add: Stock-based employee compensation expense included in  reported net loss                      |       | 337                          |       | 590 |   | 67 |   |
| Deduct: Stock-based employee compensation determined under fair  value based method for all awards |       | (1,663                       | )          | (2,688 | ) | (2,935 | ) |
| Pro forma                                                                                          |       | $                            | (21,197    | ) | $ | (9,633 | ) | $ | (26,461 | ) |
| Net loss per common share, basic and diluted:                                                      |       |                         |       |   |   |   |   |
| As reported                                                                                        |       | $                            | (0.66      | ) | $ | (0.28 | ) | $ | (0.89 | ) |
| Pro forma                                                                                          |       | $                            | (0.70      | ) | $ | (0.35 | ) | $ | (0.99 | ) |

 

The per share weighted-average fair value of stockoptions granted during 2004, 2003 and 2002, was $1.87, $1.02 and $2.01,respectively, on the grant date using the Black-Scholes option pricing modelwith the following assumptions:

 
| ** **              | ** ** | **Year ended December 31,** | ** ** |
|-------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Expected dividend yield |       | 0.0                         | %          | 0.0 | % | 0.0 | % |
| Risk-free interest rate |       | 3.43                        | %          | 2.30 | % | 3.83 | % |
| Expected volatility     |       | 120.9                       | %          | 135.7 | % | 105.0 | % |
| Expected life in years  |       | 4.0                         |       | 4.0 |   | 4.0 |   |

 

*Concentration in theAvailable Sources of Supply of Materials*: The Company is dependent onsuppliers for the timely delivery of materials and services and may experienceinterruptions in supply. The Company’s STR product in developmentrequires sufficient, reliable and affordable quantities of holmium-166, andDOTMP, the small-molecule compound used in its STR product candidate to deliverholmium-166 to the bone. There are, in general, relatively few sources of theholmium-166 component of the Company’s STR product. Historically, the Companyhas depended on a single source vendor, the University of Missouri ResearchReactor facility group (MURR) located in Columbia, Missouri. In March 

 

51

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2004, the Company enteredinto a contract, under which MURR is responsible for the manufacture, includingprocess qualification, quality control, packaging and shipping, of holmium-166for the Company’s Phase III trial.  InNovember 2004, the Company exercised its option, with MURR’s consent, to extendthe term of the agreement until March 1, 2006. The Company also has the optionto extend the agreement, with MURR’s consent, for an additional 12-month term.The contract may be terminated by either party if the other party breaches thecontract and such breach is not cured, if MURR fails to fulfill the Company’s purchaseorders on a timely basis, or if any regulatory authority orders either party tostop manufacturing or using holmium-166. Under the contract, the Company pays a fixed price per unit ofholmium-166 ordered, subject to certain minimum purchase requirements, andfixed amounts for handling and maintenance. While MURR generally has provided the Company materials with acceptablequality, quantity and cost in the past, it may become unable or unwilling tomeet the Company’s future demands, or demands of potential third-partysuppliers of the Company’s STR compound. If MURR or an alternate supplier isunable or unwilling to provide supplies of holmium-166 at a cost and on otherterms acceptable to the Company, the manufacture and delivery of the Company’sSTR product candidate could be impaired, and the Company may suffer delays in,or be prevented from, initiating or completing further clinical trials of itsSTR product candidate.

The Company obtainsDOTMP, the targeting agent for STR, from The Dow Chemical Company, from whichthe Company licenses the STR technology. Alternate suppliers of DOTMP areavailable if needed. Because the Company licenses the STR technology from Dow,the Company historically has not felt it necessary to enter into a formalsupply agreement with Dow. The Company currently believes that it has asufficient supply of DTOMP on hand to complete its Phase III trial.  The Company plans to continue to monitor thestability of the supply over time as the trial activity progresses.  If the trial takes significantly longer thananticipated or the supply is less stable than expected, the Company may need totake actions to acquire additional supplies of DOTMP.

The Company has limitedsupply of NX 473 drug product that was manufactured by a prior licensee inSeptember 2004 and earlier.  The drugproduct has been demonstrated to be stable for 12-18 months from the date ofmanufacture, which time period is not sufficient for the Company to completeits proposed clinical trials of NX 473. The Company will need to identify a new manufacturer of additional NX473 drug product to complete its planned Phase II clinical trial in small celllung cancer. If the Company is unable to demonstrate increased stability oridentify a new manufacturer for NX 473 on a timely and commercially reasonablebasis, it may be required to delay the clinical trial and the trial expensesmay increase. There are a limited number of contract manufacturers able to makedrug products, such as NX 473.  TheCompany is in the process of identifying potential manufacturers of NX473.  There is no assurance that theCompany will be able engage a reliable manufacturer or to obtain sufficientsupplies of NX 473 on a timely or cost-effective basis.

*Fair Value of Financial Instruments*:  The Company has financial instrumentsconsisting of cash, cash equivalents, investment securities, notes receivable,accounts payable and notes payable.  Thefair value of all of the Company’s financial instruments, based on either theshort-term nature of the instrument, current market indicators or quotes frombrokers, approximates their carrying amount.

 

*Segment Reporting:* The Company has one operating business segment.

 

*Reclassifications:* Certain prior year amounts have been reclassified to conform to thecurrent year presentation.

 

* *

52

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*New Accounting Pronouncements:*  In December 2004, the FinancialAccounting Standards Board issued Statement of Financial Accounting Standards(SFAS) No.123R, Share-Based Payment. SFAS 123R replaces SFAS 123,Stock-Based Compensation, issued in 1995. SFAS 123R requires that the fairvalue of the grant of employee stock options be reported as an expense in the results of operationsbeginning no later than July 1, 2005.  Historically, the Company has disclosed inits footnotes the pro forma expense effect of the grants.   Stockcompensation expense under the prior rules would have increased reporteddiluted loss per share by $.04 in 2004. Upon adoption of the revised standard, prior awards will be charged toexpense under the prior rules, and awards after adoption will be charged toexpense under the revised rules.  TheCompany has not determined the effect of the new standard on itsearnings; however, expense under the new standard could be higher. The effectof adopting the new rules on reported diluted earnings per share is dependenton the number of options granted in the future, the terms of those awards, andtheir fair values and, therefore, the effect on diluted earnings per sharecould change. The Company expects to adopt the revised rules on July 1,2005, but has not determined whether it will adopt prospectively orretrospectively to January 1, 2005. The adoption of the Statement is expected to have a material effect onthe financial statements.

#### **NOTE 3.  Liquidity and Capital Resources**

The Company willneed to raise additional capital to fund its STRTM Phase III clinical trial, toinitiate clinical development of its NX 473 platinum compound, and to fund itsfuture operating cash needs.

In April 2003, theCompany received $10,000,000 from the sale to Boston Scientific Corporation ofcertain non-core NeoRx intellectual property and the grant to Boston ScientificCorporation of certain license rights. In December 2003, the Company raised approximately $14,600,000 throughthe sale in a private placement of shares of a newly created class of Series BConvertible Preferred Stock (Series B Preferred Stock), which, on an asadjusted basis (see Note 11 below), are convertible, at a price of $4.57 pershare, into  3,446,389 shares of CommonStock, and warrants to purchase an aggregate of 630,000 common shares at $6.00per share. The Company raised approximately $9,000,000 in net proceeds from thesale of Common Stock and warrants in a private placement transaction inFebruary 2004. The Company raised approximately $3,900,000 in net proceeds fromthe sale of common stock and warrants in March 2005 (the March 2005 Financing).

During 2002, theCompany discontinued all Pretarget technology activities, reduced staffing by67% and terminated the lease for its facilities at 410 West Harrison Street inSeattle, effective in April 2003. Pretarget technology is a development platform for targetedimmunotherapeutics that deliver intense doses of anti-cancer agents to tumorcells while largely sparing healthy tissues.

In connection with its2001 purchase of the radiopharmaceutical manufacturing plant and other assetslocated in Denton, TX, the Company assumed $6,000,000 principal amount ofrestructured debt held by Texas State Bank, McAllen, TX.  The loan, which matures in April 2009, issecured by the assets acquired in the transaction.  The interest rate on the loan was 5.25% onDecember 31, 2004.  The interest rate,which is equal to the bank prime rate, is reset in April of each year.  The loan provides for a maximum annualinterest rate of 18%.  Principal andinterest are payable in monthly installments. Principal and interest paid on the note during 2004 totaled $486,000. InDecember 2003, the Company sold a non-essential portion of its Dentonfacility, the proceeds of which ($827,000) were applied to reduce theoutstanding balance on the loan. As of December 31, 2004, the outstandingbalance of the loan was $4,207,000. The fixed monthly payments on the note arerecalculated in April of each year based on the then current bank primeinterest rate and outstanding note balance. Because the loan is amortized over a fourteen-year period from itsinception, a principal balance will remain at maturity in April 2009.  Based on an interest rate of 5.25%, theestimated principal balance payable at maturity would be $2,754,000.

During2002 and early 2003, the Company reduced the staff at the Denton facility tofour employees and operated the facility in standby mode.   In the second half of 2003, the Companyre-staffed the facility in preparation for resumption of manufacturingactivities in the first quarter of 2004. The terms of the Texas State Bank loan provide that an event of defaultmay be deemed to occur if the 

 

53

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Company abandons, vacates or discontinues operationson a substantial portion of the Denton facility or there is a material adversechange in the Company’s operations. The Company does not believe that operatingthe facility in standby mode during 2002 and early 2003 violated theseprovisions, nor has Texas State Bank suggested that it views such activities asa potential violation. The Company can provide no assurance, however, thatTexas State Bank will not at some time in the future seek to rely on these orother provisions of the loan to declare the Company in default of the loan. Ifthis were to occur, Texas State Bank could declare the entire outstandingamount of the loan ($4,207,000 at December 31, 2004) due and immediatelypayable. In such case, the Company’s cash resources and assets could beimpaired depending on its ability to raise funds through a sale of the Dentonfacility and other means. Based on a November 2002 appraisal of the Dentonfacility, the fair value of the facility and its assets exceeds the amount ofthe outstanding debt.

In April 2004, theCompany sold and transferred its Pretarget intellectual property to AletheonPharmaceuticals, Inc.  Under theagreement, the Company could receive up to $6.6 million in milestone paymentsif Aletheon achieves certain development goals, plus royalties on potentialfuture product sales.  The Company didnot receive any upfront consideration for the sale of the Pretarget property.  The Company discontinued its clinical studiesusing the Pretarget technology in July 2002, and since that time, had beenactively seeking, both through targeted inquiries and a broad-based auctionprocess, a buyer or licensee for the technology.  The sale of the Pretarget intellectualproperty relieves the Company of the annual costs associated with maintainingthe Pretarget patent estate.  During2003, the Company spent approximately $350,000 for the prosecution andmaintenance of the Pretarget patents and trademarks.  For 2004, these costs were expected to be inthe range of $200,000 to $600,000. Seattle-based Aletheon is a development stage biotherapeutics companyfounded by two former Company employees. The timing and amount of milestone payments, if any, are uncertain.  The terms of the transaction were determinedthrough arms-length negotiation.  Neitherthe Company nor Bay City Capital LLC and its affiliates at any time has held,or in the future plans to acquire, a financial interest in Aletheon.

 

The Company’s actual capital requirements will dependupon numerous factors, including:

•              the rate of progressand costs of its STR clinical trial and research and development activities,including the Company’s ability to activate clinical sites and enroll qualifiedpatients into its STR Phase III clinical trial;

•              the Company’sability to obtain clinical material from third-party suppliers and manufactureSTR in a timely and cost-effective manner;

•              actions taken by theUS Food and Drug Administration (FDA) and other regulatory authorities;

•              the scope and timingof the Company’s proposed NX 473 clinical program and other research anddevelopment efforts;

•              the acquisition orin-licensing of other products or intellectual property, if the Company choosesto undertake such activities;

•              the costs ofdiscontinuing projects and technologies or decommissioning existing facilities,if the Company undertakes those activities;

•              the timing andamount of any milestone or other payments the Company might receive frompotential strategic partners and licensees;

•              the Company’s degreeof success in commercializing its STR, NX 473 or any other cancer therapyproduct candidates;

•              the emergence ofcompeting technologies and products, and other adverse market developments; and

 

54

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•              the costs ofpreparing, filing, prosecuting, maintaining and enforcing patent claims andother intellectual property rights.

There can be no assurance that the Company willbe able to obtain needed additional capital or enter into relationships withcorporate partners on a timely basis, on favorable terms, or at all.  Conditions in the capital markets in generaland the life science capital market specifically may affect the Company’spotential financing sources and opportunities for strategic partnering.  See Note 1.

 

#### **NOTE 4. Investment Securities**

 

Investment securities consisted of thefollowing (in thousands):

 
| ** **                                                                                                                                                       | ** ** | ** **               | ** ** | ** **            | ** ** | **December 31,**     | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|----------------------|------------|
| ** **                                                                                                                                                       | ** ** | ** **               | ** ** | ** **            | ** ** | **2004**             | ** ** | **2003** | ** ** |
| Federal government and agency securities                                                                                                                         |       |                     |       |                  |       | 1,499                |       | 12,335 |   |
|                                                                                                                                                             |       |                     |       |                  |       | $                    | 1,499      |   | $ | 12,335 |   |
|                                                                                                                                                             |       |                     |       |                  |       |                 |       |   |   |
| Unrealized gains  and losses at December 31, 2004 are as follows (in thousands):

                                                                          |
| ** **                                                                                                                                                       | ** ** | **Amortized Cost Basis** | ** ** | **Fair Market Value** | ** ** | **Unrealized Gains** | ** ** | **Unrealized Losses** | ** ** |
| Federal government and agency securities                                                                                                                         |       | $                        | 1,500      |                  | $          | 1,499                |       | $ | — |   | $ | (1 | ) |
|                                                                                                                                                             |       | $                        | 1,500      |                  | $          | 1,499                |       | $ | — |   | $ | (1 | ) |
| Net unrealized losses                                                                                                                                            |       |                     |       |                  |       |                 |       | $ | (1 | ) |
|                                                                                                                                                             |       |                     |       |                  |       |                 |       |   |   |
|                                                                                                                                                             |       |                     |       |                  |
| Unrealized gains  and losses at December 31, 2003 are as follows (in thousands):

                                                                          |
| ** **                                                                                                                                                       | ** ** | **Amortized Cost Basis** | ** ** | **Fair Market Value** | ** ** | **Unrealized Gains** | ** ** | **Unrealized Losses** | ** ** |
| Corporate debt securities                                                                                                                                        |       | $                        | 12,342     |                  | $          | 12,335               |       | $ | — |   | $ | (7 | ) |
|                                                                                                                                                             |       | $                        | 12,342     |                  | $          | 12,335               |       | $ | — |   | $ | (7 | ) |
| Net unrealized losses                                                                                                                                            |       |                     |       |                  |       |                 |       | $ | (7 | ) |
|                                                                                                                                                             |       |                     |       |                  |       |                 |       |   |   |
|                                                                                                                                                             |       |
| At December 31, 2004, the Company owned a federal government  security that equaled approximately $1,499,000 and that matures during the  first quarter of 2005. |       |
|                                                                                                                                                             |       |                     |       |                  |       |                 |       |   |   |
| **NOTE 5.  Accrued Liabilities**                                                                                                                            |

 
| Accrued  liabilities consist of the following (in thousands): |
|---------------------------------------------------------------|
| ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **December 31,** | ** ** |
| ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Accrued expenses                                              |   |   |   |   |   | $ | 486 |   | $ | 517 |   |
| Compensation                                                  |   |   |   |   |   | 542 |   | 459 |   |
| Decommissioning costs                                         |   |   |   |   |   | 194 |   | 200 |   |
| Severance                                                     |   |   |   |   |   | — |   | 44 |   |
| Other                                                         |   |   |   |   |   | 49 |   | 75 |   |
|                                                          |   |   |   |   |   | $ | 1,271 |   | $ | 1,295 |   |

#### ** **

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#### **NOTE 6.  Note Payable**

#### ** **

#### ****In connection with the Company’s April 19, 2001, acquisition of aradiopharmaceutical manufacturing facility and certain other related assets inDenton, TX, the Company assumed a $6,000,000 note payable.  The terms of the note payable includeinterest at a variable interest rate equal to the prime rate as published in *The**Wall Street Journal.*The interest rate on theloan was 5.25% on December 31, 2004.  Thefixed monthly payment amount is re-caclucated in April of each year.  The loan provides for a maximum annual interestrate of 18%. Principal and interest are payable in monthly installments.Principal and interest paid on the note during 2004 totaled $486,000. InDecember 2003, the Company sold a non-essential portion of its Dentonfacility, the proceeds of which ($827,000) were applied to reduce theoutstanding balance on the loan. As of December 31, 2004, the outstandingbalance of the loan was $4,207,000.  The note balance is due when the note maturesin April 2009.  The assets acquiredsecure the note payable.  The terms of the loanprovide that an event of default may be deemed to occur if the Companyabandons, vacates or discontinues operations on a substantial portion of theDenton facility or there is a material adverse change in its operations. Ifthis were to occur, Texas State Bank could declare the entire outstandingamount of the loan ($4.2 million at December 31, 2004) due and immediatelypayable.

#### ** **

| Note payable maturities as of December 31, 2004, are as follows  (in thousands): |   |   |   |
|----------------------------------------------------------------------------------|--------|--------|--------|
|                                                                             |   |   |   |
| **Year**                                                                         |   |   |   |
| 2005                                                                             |   | $      | 302    |   |
| 2006                                                                             |   | 337    |   |
| 2007                                                                             |   | 355    |   |
| 2008                                                                             |   | 374    |   |
| 2009                                                                             |   | 2,839  |   |
| Total                                                                            |   | $      | 4,207  |   |

 

#### **NOTE 7.  Line of Credit**

 

In 2000, theCompany established a line of credit with Pharmaceutical Product Development,Inc. (PPD) of up to $5,000,000 to assist in funding the Company’s pivotal PhaseIII trial of its STR product candidate. The line expired in February 2004. No funds were drawn against the line through the date of termination.

 

In connection withthe line of credit, the Company issued PPD a warrant to purchase 75,000 sharesof Company Common Stock at an exercise price of $6.7734.  The Company recorded the fair value of thewarrant as a deferred cost within other assets, which was being amortized overthe expected term of the line of credit. Based upon the Black-Scholes option-pricing model, the grant-date fairvalue of the warrant was $5.32 per share using assumptions of expectedvolatility of 112%, contractual warrant term of four years, expected dividendrate of zero and a risk-free rate of interest of 6.1%.  The warrant expired in February 2004.

 

# **NOTE8.  Asset Impairment Loss**

 

In September 2002, the Company recognized an assetimpairment loss of $5,600,000 on certain facilities and equipment resultingfrom the Company’s decisions to reduce staff at its Denton, TXradiopharmaceutical manufacturing facility, eliminate contract manufacturingactivities in Denton, and curtail Pretarget activities at its Seattle, WAresearch and development facility. The loss on the Denton manufacturingfacility and related equipment was determined via outside appraisals.  The loss on the equipment at the Seattlefacility was determined via estimates of potential sales values of usedequipment.  These impairment chargesestablished new cost bases for the impaired assets.  An additional impairment charge of $616,000 relatingto intangible assets for licenses and processes at the Company’s Dentonmanufacturing facility was recorded in the fourth quarter of 2002. The fourthquarter impairment charge was associated with the Company’s decision to operateits manufacturing facility on a standby basis pending resumption of clinicaltesting of STR and production of clinical materials.

 

56

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The following table summarizes information related tothe impairment charges:
| **Description**                                      | ** ** | **Impairment Loss** | ** ** | **Post Impairment Carrying Value** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-----------------------------------------|------------|
| ** **                                           | ** ** | ** **          | ** ** | ** **                              | ** ** |
| Equipment —  Seattle, WA                        |       | $                   | 306,000    |                                    | $          | 1,025,000 |   |
| Equipment —  Manufacturing Facility, Denton, TX |       | 2,393,000           |       | 1,394,000                               |       |
| Manufacturing  Facility — Denton, TX            |       | 2,895,000           |       | 5,630,000                               |       |
| Intangibles —  Denton, TX                       |       | 622,000             |       | —                                  |       |
| Total                                                |       | $                   | 6,216,000  |                                    | $          | 8,049,000 |   |
|                                                      |            |                     |            |                                         |            |  |  |  |  |

 

# **NOTE9.  Restructuring**

In July 2002, October2002, and January 2003 the Company restructured its operations and reduced itswork force by 31, 13 and 21 employees, respectively.  The Company incurred severance charges ofapproximately $529,000, $122,000 and $214,000 as a result of the restructuringsin July 2002, October 2002, and January 2003, respectively.  The charges from the January 2003 reduction areconsidered part of the 2002 restructuring as the Company had a substantiveseverance plan in place and had made the decision as of December 31, 2002, suchthat it was probable the employees would be terminated.   At December 31, 2002, $307,000 remainedaccrued related to these terminations.  The Company incurred additional, non-employeecharges totaling $290,000 related to the closure of a research facility inSeattle, and primarily consisting of lease shut-down and clean-up costs.  This entire amount was paid as of December31, 2003.

 

#### **NOTE 10.  Leases and Commitments**

*Leases. *The lease agreements for theCompany’s principal locations expire in 2006 and 2009.  Total rent expense under operating leases wasapproximately $673,000, $722,000, and $1,309,000 for 2004, 2003 and 2002,respectively.

 

| Minimum lease  payments under operating leases as of December 31, 2004, are as follows (in  thousands): |
|---------------------------------------------------------------------------------------------------------|
|                                                                                                    |   |   |   |
| **Year**                                                                                                | ** ** | ** ** |   |
| 2005                                                                                                    |   | $ | 652 |   |
| 2006                                                                                                    |   | 620 |   |
| 2007                                                                                                    |   | 569 |   |
| 2008                                                                                                    |   | 548 |   |
| Thereafter                                                                                              |   | 320 |   |
| Total minimum lease payments                                                                            |   | $ | 2,709 |   |

*Commitments. *In March 2004, the Company entered into a contractwith the University of Missouri Research Reactor facility group (MURR) locatedin Columbia, Missouri, under which MURR is responsible for the manufacture,including process qualification, quality control, packaging and shipping, ofholmium-166 for the Company’s STR Phase III trial.  In November 2004, the Company exercised itsoption, with MURR’s consent, to extend the term of the agreement until March 1,2006. The Company also has the option to extend the agreement, with MURR’sconsent, for an additional 12-month term. Under the contract, the Company pays a fixed price per unit ofholmium-166 ordered, subject to certain minimum purchase requirements, andfixed amounts for handling and maintenance. During 2004 the Company purchased the minimum quantities under thecontract, which totaled approximately $510,000. Minimum purchases during 2005 under the contract are estimated to beapproximately $630,000.  The contract maybe terminated by either party if the other party breaches the contract and suchbreach is not cured, if MURR fails to fulfill the Company’s purchase orders ona timely basis, or if any regulatory authority orders either party to stopmanufacturing or using holmium-166.

 

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#### **NOTE 11.  Shareholders’ Equity**

 

*Common Stock Transactions*: In March 2005, the Company raised approximately $3,900,000 in netproceeds through the sale in a private placement (the March 2005 Financing) of3,320,000 shares of Common Stock.  Inconnection with the March 2005 Financing, the Company issued five-year warrantsto purchase an aggregate of 1,328,000 shares of Common Stock at an exerciseprice of $2.00 per share.  In addition,the placement agent in the March 2005 Financing was granted a warrant, on thesame terms as those received by the purchasers in that transaction, for 199,200shares of Common Stock.  The Company hasagreed to register the shares of Common Stock issued in the March 2005Financing, and the shares of Common Stock issuable upon exercise of the relatedwarrants, with the SEC.  If aregistration statement is not declared effective within ninety days of thepublic announcement of the March 2005 Financing, the Company may be required topay to partial liquidated damages of up to $62,250 per month untileffectiveness of the registration statement.

In February 2004, the Company raised approximately $9,000,000 innet proceeds through the sale in a private placement (the 2004 Financing) of1,845,000 shares of Common Stock.   Inconnection with the 2004 Financing, the Company issued five-year warrants topurchase an aggregate of 922,500 shares of Common Stock at $7.00 pershare.  The 1,845,000 shares of CommonStock issued in the 2004 Financing, and the shares of Common Stock issuableupon exercise of the warrants related thereto, have been registered with theSEC.

In April 2004, the Company issued 244,000 shares of Common Stockvalued at $1,000,000 as a partial payment to purchase an exclusive license todevelop, manufacture and commercialize NX 473, a platinum-based anti-canceragent.  The 244,000 shares of commonstock issued in this licensing arrangement have been registered with the SEC.

During 2004, the Company generated approximately $800,000 in netproceeds from the issuance of 817,000 common shares related to the exercises ofemployee stock options.

During 2003, theCompany received approximately $1,872,000 in net proceeds from the issuance of1,188,000 common shares related to the exercises of employee stock options.  Also during 2003, the Company issued 70,000common shares to officers as payment for a portion of bonus expense accrued asof December 31, 2002, and issued 10,000 common shares to an outside consultant,for which $4,000 consulting expense was recorded.  Finally in 2003 the Company accepted thesurrender of 30,000 common shares, with a value of $94,000, from a formerexecutive as payment for the exercise of an option grant to purchase 200,000common shares.  These 200,000 commonshares are included in the total 1,188,000 common shares issued for employeestock option exercises in 2003.

 

During 2002, theCompany received approximately $21,000 in net proceeds from the issuance of12,000 common shares related to the exercises of employee stock options and theissuance of 32,000 common shares related to the exercises of stockwarrants.  Also during 2002, the Companyissued 150,000 common shares to an officer of the Company and recorded $67,000in compensation expense.

 

*Preferred StockTransactions.*  During 2003 the Company raised approximately$14,611,000 through the sale of 1,575 shares of a newly created class of SeriesB Convertible Preferred Stock with attached warrants to buy 630,000 shares ofCommon Stock.  Holders of Series BPreferred Stock are entitled to receive a cash dividend only if and whendeclared by the Board of Directors of the Company (the Board).  As of December 31, 2004, no dividend had beendeclared.  There is no mandatory dividendon the Series B Preferred Stock.  AtDecember 31, 2004, each share of Series B Preferred Stock was convertible, atany time at the holder’s option, into 2,000 shares of Common Stock, at aconversion price of $5.00 per share, subject to adjustment.  The Series B Preferred Stock containsanti-dilution provisions that require the conversion price to be adjusted inthe event of stock dividends and combinations, certain distributions, andcertain issuances of additional shares of Common Stock at a purchase pricebelow the then current conversion price. Giving effect to the antidilution adjustment occurring as aresult of this financing, the outstanding shares of Series B Preferred Stockhave a conversion price of $4.57 per share and are convertible into 3,446,389 sharesof common stock.  Upon the occurrence of a liquidation event (generally defined as aCompany-approved change in control 

 

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transaction, such as a merger,share exchange, consolidation, reorganization, sale of substantially allassets, dissolution or liquidation), the holders of Series B Preferred Stockare entitled to receive a minimum payment, in cash, securities or other assets,of $10,000 per share.  Holders of SeriesB Preferred Stock are entitled to vote, together as one class with the CommonStock holders (except as required by law or the Certificate of Designation forthe Series B Preferred Stock), on all matters on which the Common Stock holdershave the right to vote.  Each holder ofSeries B Preferred Stock is entitled to the number of votes equal to the numberof shares of Common Stock into which the holder’s shares of Series B PreferredStock could be converted on the record date for the taking of such vote.

Certain provisions of theInvestor Rights Agreement for the Series B Preferred Stock require the Companyto pay cash liquidated damages if the registration statement filed with the SECto register the shares of Common Stock issuable upon conversion of the Series BPreferred Stock and exercise of the warrants is not first declared effective bythe SEC on or before March 2, 2004 (ninety days after sale of the Series BPreferred Stock).  The Company filed aregistration statement with respect to the Common Stock underlying the Series BPreferred Stock and warrants on December 19, 2003.  The Company subsequently was advised that theSEC would, as part of its corporate compliance monitoring process, conduct afull review of the registration statement and the Company’s periodicreports.  As a consequence of the SECreview process, the registration statement did not become effective until March17, 2004.  The Company therefore may berequired to pay holders of Series B Preferred Stock cash liquidated damagesequal to 1.5% of the purchase price of the Series B Preferred Stock for each30-day period (pro rated for periods of less than 30 days) for which theregistration statement was not effective. The amount of liquidated damages that accrued for the fifteen-day periodafter March 2, 2004, is approximately $118,000.

Holders of Series 1 Preferred Stock are entitled to receive anannual cash dividend of $2.4375 per share if declared by the Board, payablesemi-annually on June 1 and December 1. Dividends are cumulative.  Eachshare of Series 1 Preferred Stock is convertible into 1.14 shares of CommonStock, subject to adjustment in certain events. The Series 1 Preferred Stock is redeemable at the option of the Companyat $25.00 per share.  Holders of Series 1Preferred Stock have no voting rights, except in limited circumstances.  Dividends of $500,000 were paid in each ofthe years 2004, 2003, and 2002, respectively.

 

*Shareholders’ RightsPlan*: TheCompany has adopted a Shareholders’ Rights Plan intended to protect the rightsof shareholders by deterring coercive or unfair takeover tactics.  The Board declared a dividend to holders ofthe Company’s Common Stock, payable on April 19, 1996, to shareholders ofrecord on that date, of one preferred share purchase right, also known as theRight, for each outstanding share of the Common Stock.  The Right is exercisable 10 days followingthe offer to purchase or the acquisition of a beneficial ownership of 20% ofthe outstanding Common Stock by a person or group of affiliated persons.  (The date of such offer or acquisition is calledthe Distribution Date.)  The Companyamended the Rights Plan in December 2003, to provide that each holder of theCompany’s Series B Preferred Stock would receive, on the DistributionDate, the number of Rights equal to the number of Rights such holder would haveheld if, immediately prior to the Distribution Date, all of the shares ofSeries B Preferred Stock had been converted into shares of Common Stock atthe then current conversion price.  EachRight entitles the registered holder, other than the acquiring person or group,to purchase from the Company one-hundredth of one share of Series A JuniorParticipating Preferred Stock, also known as Series A Preferred Stock, at aprice of $40, subject to adjustment.  TheRights expire in 2006.  The Series APreferred Stock will be entitled to a minimum preferential quarterly dividendof $1 per share and has liquidation provisions. Each share of Series A Preferred Stock has 100 votes, and will vote withthe Common Stock.  Prior to theacquisition by a person or group of 20% of the outstanding Common Stock, theBoard may redeem each Right at a price of $.001.  In lieu of exercising the Right by purchasingone one-hundredth of one share of Series A Preferred Stock, the holder of theRight, other than the acquiring person or group, may purchase for $40, thatnumber of shares of the Company’s Common Stock having a market value of twicethat price.

 

The Board may,without further action by the shareholders of the Company, issue PreferredStock in one or more series and fix the rights and preferences thereof,including dividend rights, dividend rates, 

 

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conversion rates, voting rights,terms of redemption, redemption price or prices, liquidation preferences andthe number of shares constituting any series or the designations of suchseries.

 

*Stock Options*: At December 31, 2004, the Company had two stock option plans under whichoptions were available for grant: the 2004 Incentive Compensation Plan (the2004 Plan) and the 1991 Stock Option Plan for Non-Employee Directors (theDirectors Plan).  The Company’s 1994Stock Option Plan (the 1994 Plan) terminated on February 17, 2004 and nofurther options can be granted under that plan.

 

The 2004 Planauthorizes the Board or a Committee appointed by the Board to grant options topurchase a maximum of 3,000,000 shares of Common Stock.  The 2004 Plan allows for the issuance ofincentive stock options and nonqualified stock options to employees, officers,directors, agents, consultants, advisors and independent contractors of theCompany, subject to certain restrictions. All option grants expire ten yearsfrom the date of grant, except for certain grants to consultants, which haveexpirations based upon terms of service. Option grants for employees with at least one year of service becomeexercisable in monthly increments over a four-year period from the grantdate.  Option grants for employees withless than one year of service and employees receiving promotions become exercisableat a rate of 25% after one year from the grant date and then in monthlyincrements at a rate of 1/48th per month over the following three years.  As of December 31, 2004, there were 1,854,259shares of Common Stock available for grant under the 2004 Plan.  No shares are available for grant under the1994 Plan since its expiration in February 2004, although options granted underthe 1994 Plan prior to its expiration continue in effect in accordance withtheir terms.

 

In May 2000, theCompany amended the 1994 Plan to provide that an employee will have two yearsto exercise the vested portion of an option upon retirement from the Company,whereas the employee previously had three months to exercise such option.  Compensation expense equal to the intrinsicvalue of an employee’s option at the modification date will be recorded foremployees that receive an extension of their options upon retirement.  The intrinsic value at the modification datefor the options subject to the modifications that were outstanding at December31, 2004, totaled approximately $1,778,000.

In connection with a severance and consulting agreement with aformer officer, the Company accelerated the vesting of stock options to acquire100,000 shares of Common Stock in 2001. The Company recorded compensation expense of approximately $13,000 and$94,000  in 2003 and 2002, respectively,in connection with the severance and consulting arrangement.

 

In July 2001, the Company granted stock options pursuant to anagreement outside the Company’s 1994 Plan and the Directors Plan to an officerof the Company to purchase 150,000 shares of Common Stock at an exercise priceof $3.35 per share.  In June 2003, theoptions were modified to expire twelve months after termination of service tothe Company.  The Company recordedcompensation expense of $6,000 related to the modification of these options.

In connection with an agreementwith a consultant in 2004 for strategic planning consulting services, theCompany granted stock options to purchase 50,000 shares of Common Stock at anexercise price of $2.24.  The options  vested on February 27, 2005.  Compensation expense is recorded for the fairvalue of the grant over the period the services are provided by theconsultant.  Based upon the Black-Scholesoption-pricing model, the fair value of the options ranged from $1.31 to $1.67per share using assumptions of expected volatility of 119%, contractual termsof ten years, expected dividend rate of zero and risk-free rates of interest of3.1% to 3.6%.  The Company recordedcompensation expense of approximately $37,000 in 2004.

In April 2004, theCompany extended to December 31, 2004 the time to exercise stock options, heldby a former officer, to acquire approximately 160,000 shares of CommonStock.  The Company recorded compensationexpense of $322,000.  Also in April 2004,in connection with a consulting agreement with a former employee, the Companyextended the vesting of the stock options to acquire approximately 64,000shares of Common Stock.  The Companyrecorded compensation expense of $15,000.

 

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In connection withan agreement with a consultant for consulting services, in 2003 the Companygranted stock options to purchase 26,400 shares of Common Stock at an exerciseprice of $0.47 per share.  The optionsvested immediately upon the grant date. Compensation expense was recorded for the fair value of the grant at thegrant date.  Based upon the Black-Scholesoption-pricing model, the fair value of the options was $0.27 per share usingassumptions of expected volatility of 131%, a contractual term of up to tenyears, an expected dividend rate of zero and a risk-free rate of interest of1.2%.  The Company recorded compensationexpense of approximately $7,000 in 2003 related to this grant.

 

In connection withvarious agreements with consultants in 2002 for consulting services, theCompany granted stock options to purchase 115,000 shares of Common Stock atexercise prices ranging from $2.45 to $3.50 per share.  The options vest at various intervals up tothree years after the grant date. Compensation expense is recorded for the fair values of the grants overthe period the services are provided by the consultants.  Based upon the Black-Scholes option-pricingmodel, fair values of the options ranged from $0.01 to $5.32 per share usingassumptions of expected volatilities ranging from 85% to 141%, contractualterms of up to ten years, expected dividend rate of zero and risk-free rates ofinterest ranging from 1.2% to 4.1%.  TheCompany recorded a credit to compensation expense of approximately $12,000 in2004 and compensation expense of approximately $167,000 and $18,000 in 2003 and2002, respectively, related to these grants. The fair value of the options with future vesting dates will not beknown until the earlier of the vesting of the options or the completion of theservices being provided.

 

In connection withvarious agreements with consultants in 2001 for consulting services, theCompany granted stock options to purchase 170,000 shares of Common Stock atexercise prices ranging from $2.34 to $5.53 per share.  The options vested at various intervals up totwo years after the grant date.  Alloptions vested during 2003.  Compensationexpense was recorded for the fair values of the grants over the period theservices were provided by the consultants. Based upon the Black-Scholes option-pricing model, fair values of theoptions ranged from $2.57 to $4.86 per share using assumptions of expectedvolatilities ranging from 98% to 146%, contractual terms of up to ten years,expected dividend rate of zero and risk-free rates of interest ranging from1.7% to 4.7%.  The Company recorded acredit to compensation expense of approximately $66,000 in 2002 andcompensation expense of approximately $81,000 in 2003 related to these grants.

 

The Directors Planauthorizes the grant of stock options to non-employee directors to purchase amaximum of 250,000 shares of Common Stock. Under the terms of the amended plan, each eligible director receivesannually, concurrent with the annual election of directors, an option topurchase 10,000 shares of Common Stock at an exercise price equal to the fairmarket value of the Common Stock on the date of grant.  The options become exercisable in two equalannual installments beginning with the first annual meeting of shareholdersafter the date of grant.  In addition,each newly appointed non-employee director receives a one-time initial optionto purchase 20,000 shares of Common Stock at an exercise price equal to thefair market value of the Common Stock on the date of grant.  Options expire on the earlier of ten yearsfrom the date of grant or five years after the director’s termination ofservice as a director.  As of December31, 2004, there were 82,500 shares of Common Stock available for grant underthe Directors Plan.

 

Informationrelating to stock option activity is as follows (in thousands, except per sharedata):

 
| ** **                       | ** ** | **2004**             | ** ** | **2003**                             | ** ** | **2002**             | ** ** |
|----------------------------------|------------|----------------------|------------|--------------------------------------|------------|----------------------|------------|
| ** **                       | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| Outstanding at beginning of year |       | 4,103                |       | $                                    | 3.68       |                 | 4,495      |   | $ | 4.56 |   | 4,614 |   | $ | 5.10 |   |
| Granted                          |       | 1,396                |       | 2.38                                 |       | 2,017                |       | 1.21 |   | 1,128 |   | 2.88 |   |
| Exercised                        |       | (818                 | )          | 0.98                                 |       | (1,188               | )          | 1.65 |   | (12 | ) | 1.81 |   |
| Cancelled                        |       | (1,153               | )          | 5.09                                 |       | (1,221               | )          | 4.77 |   | (1,235 | ) | 4.98 |   |
| Outstanding at end of year       |       | 3,528                |       | $                                    | 3.34       |                 | 4,103      |   | $ | 3.70 |   | 4,495 |   | $ | 4.56 |   |
| Exercisable at end of year       |       | 1,843                |       | $                                    | 4.12       |                 | 2,953      |   | $ | 4.02 |   | 2,993 |   | $ | 4.98 |   |

 

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| Information relating to stock options outstanding and  exercisable at December 31, 2004, is as follows (in thousands, except per  share data): |
|------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                     | ** ** | ** ** | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** |   |
| **Range of Exercise  Prices**                                                                                                                  | ** ** | ** ** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Remaining Life  in Years** | ** ** | **Weighted  Average Exercise Price** | ** ** | **Number of Shares** |   | **Weighted  Average Exercise Price** |   |
| $0.47 - $2.02                                                                                                                                  |   |   |   | 926 |   | 7.79 |   | $ | 1.07 |   | 645 |   | $ | 0.76 |   |
| $2.24 - $2.45                                                                                                                                  |   |   |   | 111 |   | 7.77 |   | 2.31 |   | 31 |   | 2.38 |   |
| $2.50 - $2.50                                                                                                                                  |   |   |   | 996 |   | 9.38 |   | 2.50 |   | 42 |   | 2.50 |   |
| $2.57 - $18.25                                                                                                                                 |   |   |   | 1,496 |   | 6.56 |   | 5.39 |   | 1,125 |   | 6.15 |   |
|                                                                                                                                           |   |   |   | 3,528 |   | 7.72 |   | $ | 3.34 |   | 1,843 |   | $ | 4.12 |   |

 

 

 

*Restricted Stock*. The Company has a Restricted Stock Plan (the Restricted Stock Plan)under which restricted stock may be granted or sold to selected employees,officers, agents, consultants, advisors and independent contractors of theCompany.  Under the Restricted StockPlan, which was adopted in 1991, 400,000 shares are authorized for grant, ofwhich 60,250 shares remained available for grant at December 31, 2004.  There were 70,000 shares granted withoutrestrictions during 2003, of which 10,000 shares were for consultingservices.  The remaining 60,000 shares,valued at $33,000, were used to settle bonuses that were accrued at December31, 2002.  There were 150,000 sharesgranted without restrictions during 2002 for services.  There were 50,000 shares granted withoutrestrictions and 10,000 shares granted subject to certain performancerequirements during 2001 for services provided or to be provided to theCompany.  The performance requirementsrelated to the 10,000 shares granted were not met, and the grant wasrevoked.  The Company recorded expenserelated to these grants of approximately $4,000 in consulting expense in 2003and $67,000 in compensation expense in 2002.

 

*Warrants*. In connection with the 2004 Financing, the purchasers received five-yearwarrants to purchase an aggregate of 922,500 shares of Common Stock, at anexercise price of $7.00 per share. The warrants became exercisable beginning onFebruary 23, 2004 and, thereafter, are exercisable at any time during theirterm.  The warrants contain provisionsrequiring the adjustment of the exercise price and number of shares issuable ifthe Company sells (other than in connection with certain permittedtransactions, such as strategic collaborations and acquisitions approved by theBoard) shares of Common Stock at a price lower than the then-current exerciseprice of the warrants. Giving effect to the antidilution adjustmentoccurring as a result of the March 2005 Financing, the warrants wereexercisable for an aggregate of 1,033,200 shares of Common Stock at an exerciseprice of $6.25.   The warrants are redeemable at the election of the Company at anytime after March 24, 2006, if the volume-weighted average price of theunderlying Common Stock for each trading day over a period of 20 consecutivetrading days is equal to or greater than $10.50 per share, subject toadjustment. The shares of Common Stock issuable upon exercise of the 2004Financing warrants have been registered with the SEC.  In payment of placement agent fees for the2004 Financing, the Company issued three-year warrants to purchase 35,000shares of Common Stock at an exercise price of $5.54 per share.   TheCompany recorded a charge to general and administrative expense of $118,000 forthe fair value of the warrants on February 23, 2004.  Based upon the Black-Scholes option-pricingmodel, the fair value of the warrants was $3.38 per share using assumptions ofexpected volatility of 124%, contractual terms of three years, expecteddividend rate of zero and a risk-free rate of interest of 2.2%.

In connection withthe sale of its Series B Preferred Stock, the purchasers of the Series BPreferred Stock received five-year warrants to purchase an aggregate of 630,000 shares of Common Stock, at an exercise price of$6.00 per share.  The warrants become exercisable on June 3, 2004.  The warrants are redeemable at the electionof the 

 

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Company at any time after December 3, 2005, if thevolume-weighted average price of the underlying Common Stock for each tradingday over a period of 20 consecutive trading days is equal to or greater than$8.50 per share, subject to adjustment. The Company recorded a charge of $1,976,000 as a net beneficialconversion feature of the Series B Preferred Stock.  The warrants were valued at $4.14 per shareusing the Black Scholes option-pricing model with assumptions of expected volatilityof 134%, contractual term of five years, expected dividend rate of zero and arisk-free rate of interest of 3.5%.  Theshares of Common Stock issuable upon conversion of the Series B Preferred Stockand exercise of the warrants have been registered with the SEC.

 

In connection with the agreementto purchase the manufacturing facility in Denton, TX, the Company on April 19,2001, issued to International Isotopes Inc. a three-year warrant to purchase upto 800,000 shares of Common Stock at a purchase price of $10.00 per share.  The warrant is exercisable at any time duringthe term of the warrant.  If at any timeduring the term of the warrant the closing price of the Company’s Common Stockequals or exceeds $20.00 per share, the Company at any time thereafter willhave the right to acquire all or any portion of the shares issuable under thewarrant at a nominal amount.  The Companymust give at least 15 days’ written notice of its election to purchase theshares issuable under the warrant and the purchase date on or after which itmay consummate such purchase.  The holderof the warrant may exercise the warrant through the payment of the exerciseprice prior to the purchase date set forth in the notice.  The warrant was valued at $1.61 per shareusing an option pricing model with assumptions of expected volatility of 125%,contractual term of three years, expected dividend rate of zero and a risk-freerate of interest of 4.6%.    The warrantexpired April 19, 2004.

 

The Company alsoissued warrants in connection with its PPD line of credit.  See Note 7.

 

# **NOTE 12.**  AssetRetirement Obligation

 

The Companyrecorded a $190,000 cumulative effect of change in accounting principle duringthe first quarter of 2003 as a result of the Company’s adoption of SFAS 143,Accounting for Asset Retirement Obligations. Under SFAS 143, the Company recorded an asset and liability in theamount of $364,000 related to the estimated fair value of futuredecommissioning costs associated with the Denton radiopharmaceutical manufacturingfacility.  This estimate was depreciatedusing a seven year estimated useful life for the asset and the asset retirementobligation was accreted using the thirty year period that represents theexpected time that will elapse prior to the settlement of the obligation.  The asset and liability were depreciated andaccreted, respectively, until December 2003, when the Company sold the realestate and equipment associated with the Denton radiopharmaceutical manufacturingfacility for which the fair value of future decommissioning costs wasestimated.  The sale of these assetseliminated the future asset retirement obligation as recorded under SFAS 143 asof December 31, 2003.  Accretion of theasset retirement obligation totaled $62,000 and depreciation expense for theasset retirement asset totaled $48,000 for the year ended December 31, 2003.

 

In addition, hadthe Company applied the provisions of SFAS 143 as of the date of acquisition ofthe Denton facility, and using current January 1, 2003, assumptions forinterest rates and decommissioning costs, depreciation expense, which wasincluded in the cumulative effect of change in accounting principle, would haveincreased by $52,000 and $39,000, respectively, for the years ended December31, 2002, and 2001.

 

#### **NOTE 13. Revenues**

 

Revenue in 2004was $1,015,000 and consisted primarily of $1,000,000 from milestone paymentsreceived from Boston Scientific Corporation in connection with certainintellectual property licensed to Boston Scientific Corporation in 2003.

 

Revenue in 2003 was $10,531,000 and consisted of$10,000,000 from the assignment and license to Boston Scientific Corporation ofcertain intellectual property and revenue from a facilities leaseagreement.  The sale to Boston ScientificCorporation included no substantive continuing involvement by the Company andhas therefore been fully recognized as revenue in 2003.

 

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Revenue in 2002 was $11,054,000 and consisted of$7,900,000 from the sale to IDEC Pharmaceuticals Corp. of certain intellectualproperty and the grant to IDEC of certain license rights, milestone paymentstotaling $2,000,000 from Angiotech Pharmaceuticals, Inc., and revenue fromgovernment grants and a facilities lease agreement.  The sale to IDEC included no substantivecontinuing involvement by the Company and has therefore been fully recognizedas revenue in 2002.

 

**NOTE14.  Federal Income Taxes**

 

Temporarydifferences and carryforwards giving rise to deferred tax assets were as follows(in thousands):

 

| ** **                                        | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|------------------|------------|
| ** **                                        | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Net operating loss carryforwards                  |       | $                | 42,231     |   | $ | 28,664 |   |
| Research and experimentation credit carryforwards |       | 8,431            |       | 7,771 |   |
| Capitalized research and development              |       | 11,957           |       | 13,182 |   |
| Property and equipment                            |       | 744              |       | 745 |   |
| Other                                             |       | 1,398            |       | 1,276 |   |
| Deferred tax assets                               |       | 64,761           |       | 51,638 |   |
| Deferred tax asset valuation allowance            |       | (64,761          | )          | (51,638 | ) |
| Net deferred taxes                                |       | $                | —     |   | $ | — |   |

 

The Company hasestablished a valuation allowance equal to the amount of deferred tax assetsbecause the Company has not had taxable income since its inception andsignificant uncertainty exists regarding the ultimate realization of thedeferred tax assets. Accordingly, no tax benefits have been recorded in theaccompanying statements of operations. The valuation allowance increased by $13,123,000,$2,552,000 and $2,219,000 in 2004, 2003 and 2002, respectively.

 

The Company hasnet operating loss carryforwards of approximately $124,000,000 which expirefrom 2005 through 2024.  Research andexperimentation credits expire from 2006 to 2024.  As a result of changes in ownership, theutilization of the Company’s net operating loss carryforwards may be limited.

 

Approximately$21,000,000 of the Company’s net operating loss carryforwards at December 31,2004, result from deductions associated with the exercise of non-qualifiedemployee stock options, the realization of which would result in a credit toshareholders’ equity.

#### ** **

#### **NOTE 15. Related Party Transactions**

 

 Dr. Fred Craves and Dr. Carl Goldfischer, bothmembers of the Company’s Board of Directors, are managing directors of Bay CityCapital, LLC, also known as BCC, a merchant bank focused on the life sciencesindustry.   The Company and BCC enteredinto an agreement whereby BCC acted as the Company’s advisor for the purpose ofidentifying opportunities to enter into strategic alliances. The Company paid aretainer fee of $25,000 and $80,000 in cash for each calendar quarter of 2003and 2002, respectively, except for the quarter ended March 31, 2003, for whichthe retainer fee was $26,667.  Retainerfee payments under this agreement totaled $21,667 and $400,000 for 2003 and2002, respectively.  The 2003 paymentsincluded the quarterly payments referenced above less $80,000 paid in 2002relating to 2003 services  The agreementalso included a percentage of consideration, ranging from one to five percent,depending on the ultimate amount of consideration raised.  BCC agreed to exclude the Boston ScientificCorporation sale and assignment of intellectual property from its agreementwith the Company, and, therefore, received no commission or other compensationrelated to the Boston Scientific transaction. The agreement expired on December 31, 2003, and the Company elected notto renew it.

 

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#### **NOTE 16.  401(K) Plan**

The Companysponsors a 401(K) plan that covers substantially all employees.  At its own discretion, the Company may makecontributions to the plan on a percentage of participants’ contributions.  The Company made contributions ofapproximately $11,000, $11,000, and $26,000 for the years ended December 31,2004, 2003, and 2002, respectively.  TheCompany has no other post employment or post retirement benefit plans.

#### **NOTE 17.  Acquisition of NX473**

In April 2004, theCompany acquired from AnorMED, Inc. the worldwide exclusive rights, excludingJapan, to develop, manufacture and commercialize NX 473, a platinum-basedanti-cancer agent.  Under the terms ofthe agreement, the Company paid AnorMED a one-time upfront milestone payment of$1.0 million in its Common Stock and $1.0 million in cash.  The agreement also provides for additionalmilestone payments to AnorMED of up to $13 million, payable in cash or a combinationof cash and Company Common Stock.  Thesemilestones include successful completion of an NX 473 Phase II study orinitiation of an NX 473 Phase III study, submission to the FDA of an NDA for NX473, regulatory approval from the FDA of NX 473 and the attainment of certainlevels of annual net sales of NX 473.  Upon regulatory approval, AnorMED wouldreceive royalty payments of up to 15% on product sales.

Licensed Productsconsists of the NX 473 amortizable intangible with a gross amount of $2,000,000and accumulated amortization of $125,000 at December 31, 2004.  Licensed Products is amortized on astraight-line basis over 12 years.  Theestimated annual amortization expense for Licensed Products is approximately $167,000for each of the years 2005 through 2009.

**NOTE18.  Unaudited Quarterly Data**

 

The followingtable presents summarized unaudited quarterly financial data (in thousands,except per share data):

 

| ** **                                    | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|-----------------------------------------------|------------|-------------------|------------|--------------------|------------|-------------------|------------|--------------------|------------|
| **2004**                                      |       |              |       |               |       |              |       |               |       |
| Revenues                                      |       | $                 | 500        |               | $          | 508               |       | $                  | 5          |   | $ | 2 |   |
| Operating expenses                            |       | 5,459             |       | 5,113              |       | 4,610             |       | 5,320              |       |
| Net loss                                      |       | (4,930            | )          | (4,582             | )          | (4,581            | )          | (5,278             | )          |
| Net loss applicable to common shares          |       | (5,055            | )          | (4,707             | )          | (4,706            | )          | (5,403             | )          |
| Net loss per common share:                    |       |              |       |               |       |              |       |               |       |
| Basic                                         |       | (0.17             | )          | (0.16              | )          | (0.15             | )          | (0.18              | )          |
| Diluted                                       |       | (0.17             | )          | (0.16              | )          | (0.15             | )          | (0.18              | )          |
| **2003**                                      |       |              |       |               |       |              |       |               |       |
| Revenues                                      |       | $                 | 116        |               | $          | 10,190            |       | $                  | 225        |   | $ | — |   |
| Operating expenses                            |       | 4,043             |       | 4,896              |       | 3,179             |       | 3,100              |       |
| Net income (loss)                             |       | (4,117            | )          | 5,328              |       | (3,123            | )          | (3,147             | )          |
| Net income (loss) applicable to common shares |       | (4,242            | )          | 5,203              |       | (3,248            | )          | (5,248             | )          |
| Net income (loss) per common share:           |       |              |       |               |       |              |       |               |       |
| Basic                                         |       | (0.16             | )          | 0.19               |       | (0.12             | )          | (0.19              | )          |
| Diluted                                       |       | (0.16             | )          | 0.18               |       | (0.12             | )          | (0.19              | )          |

 

Note: Net loss percommon share — basic and diluted may not add to net loss per common share forthe year due to rounding.

 

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**Note19.  Subsequent Event**

The Company raised approximately $3,900,000 in net proceeds from thesale of 3,320,000 shares of Common Stock in a private placement transaction in March2005.  In connection with this privateplacement, the Company issued five-year warrants to purchase an aggregate of1,328,000 shares of common stock at an exercise price of $2.00 per share.  The warrants are exercisable beginning onSeptember 3, 2005 and, thereafter, are exercisable at any time during theirterm.  The Company intends to use the netproceeds from the financing added to its existing funds to support its PhaseIII trial in STR, to initiate a Phase II trial in NX 473 in small cell lung cancerand for general working capital.  TheCompany has agreed to file a registration statement to cover the resale of theshares of Common Stock purchased in the private placement and issuable uponexercise of the warrants.

 

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***Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE***

 

NotApplicable.

 

***Item 9A.  CONTROLS AND PROCEDURES***

 

DISCLOSURE CONTROLS AND PROCEDURES

 

Under thesupervision and with the participation of the Company’s management, includingthe Company’s Chairman and Chief Executive Officer and the Chief FinancialOfficer, the Company has evaluated the effectiveness and design of itsdisclosure controls and procedures (as such term is defined in Rules 13a-15(e)and 15d-15(e)) as of the end of the period covered by this report, and, basedon their evaluation, the Chairman and Chief Executive Officer and the ChiefFinancial Officer have concluded that these disclosure controls and procedureswere effective as of December 31, 2004, in ensuring that all materialinformation required to be disclosed in the reports that the Company files orsubmits under the Securities Exchange Act of 1934, as amended, have been madeknown to them in a timely fashion.

 

INTERNAL CONTROL OVER FINANCIALREPORTING

 

(a)  Management’s Annual Report on InternalControl over Financial Reporting

 

Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting for the Company and for the assessment of the effectivenessof internal control over financial reporting. The Company’s internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with accounting principles generally accepted in the United Statedof America.  The Company’s internalcontrol over financial reporting includes those policies and procedures that(i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of theCompany’s assets; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with accounting principles generally accepted in the United Statesof America, and that the Company’s receipts and expenditures are being madeonly in accordance with authorizations of the Company’s management anddirectors; and (iii) provide reasonable assurance regarding the prevention ortimely detection of unauthorized acquisition, use or disposition of theCompany’s assets that could have a material effect on the financial statements.

 

Because ofits inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies and procedures maydeteriorate.

 

Managementconducted an evaluation of the effectiveness of the system of internal controlover financial reporting based on the framework in Internal Control IntegratedFramework issued by the Committee Sponsoring Organizations of the TreadwayCommission.  Based on this evaluation,management concluded that the Company’s internal control over financialreporting was effective as of December 31, 2004.  Management’s assessment of the effectivenessof the Company’s internal control over financial reporting as of December 31,2004 has been audited by KPMG LLP, an independent registered public accountingfirm, as stated in their report, which is included on page 43 of this AnnualReport on Form 10-K.

 

(b) Changes inInternal Control Over Financial Reporting

 

Followingthe initial evaluation of the effectiveness of the system of internal controlover financial reporting, management instituted a number of changes in internalcontrol procedures during the fourth quarter of 2004, then documented thechanges in all related systems and procedures. These changes include a)increased training and review levels for purchase orders and accounts payabletransactions to ensure proper approval, b) increased training relating to thedocumentation of vendor maintenance to ensure the existence of evidence ofapproval, c) institution of a second review of all check signatures to ensureproperly executed check disbursements, d) modification of the approval processfor 401(k) enrollment forms to ensure proper approval and e) additionaltraining to ensure the existence of evidence of Controller's review of interimfinancial statements and supporting schedules.   Management believes thesechanges enhanced the consistency and level of internal control over financialreporting within the Company and that these changes have materially affected,and are reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

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***Item 9B.  OTHER INFORMATION.***

 

Not applicable.

 

 

 

##### **PART III**

 

***Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT***

 

(a) *Directors*. The information required by this item isincorporated herein by reference to the section captioned “Election ofDirectors” in the Company’s definitive Proxy Statement for the 2005 AnnualMeeting of Shareholders to be held on June 15, 2005, filed with the Securitiesand Exchange Commission, or the Commission, pursuant to Section 14(a) of theSecurities Exchange Act of 1934, or the Exchange Act, as amended.

 

(b) *Executive Officers*. Information with respect to the Company’s executive officers is setforth below.

 
| **Name**                       | ** ** | **Age** | ** ** | **Position with the  Company**        |
|--------------------------------|------------|---------|------------|---------------------------------------|
| Gerald McMahon, PhD            |       | 50      |       | Chairman and Chief Executive Officer  |
| Karen Auditore-Hargreaves, PhD |       | 52      |       | President and Chief Operating Officer |
| Susan D. Berland               |       | 50      |       | Chief Financial Officer               |
| Linda T. Findlay               |       | 56      |       | Vice President, Human Resources       |
| Anna L. Wight, JD              |       | 50      |       | Vice President, Legal and Secretary   |

 

#### **Business Experience**

 

*Gerald McMahon, PhD,*was appointed Chief ExecutiveOfficer in May 2004 and Chairman of the Board of Directors in June 2004.Previously, he was President of SUGEN, Inc., a biopharmaceutical companyfocused on the discovery and development of novel targeted small-moleculedrugs. At SUGEN, Dr. McMahon played a key role in the discovery and developmentof several innovative cancer products, including SU-11248, a multi-targetedprotein kinase inhibitor for the treatment of advanced cancers, now in PhaseIII trials with Pfizer Inc. SUGEN was acquired by Pharmacia Corp. in 1999,which subsequently was acquired by Pfizer in 2003. Prior to his role at SUGEN,which he joined in 1993, Dr. McMahon held several R&D management positionsat Sandoz Pharmaceuticals (now Novartis), where his responsibilities includedthe establishment of external collaborations and the development of corporatealliances within the US and Europe. Dr. McMahon has contributed to more than100 scientific publications and was a Staff Scientist and PrincipalInvestigator at the Massachusetts Institute of Technology and Tufts UniversitySchool of Medicine early in his career. He holds a BS in Biology and a PhD inBiochemistry from Rensselaer Polytechnic Institute.

 

*Susan D.**Berland* joined the Company in October 2004 as Chief Financial Officer.Previously, Ms. Berland was Chief Financial Officer at DNA Sciences, Inc. from2000 to 2003, where she was responsible for the completion of several strategicfinancings. Ms. Berland joined DNA Sciences after four years at MonsantoCompany, leading up to the merger of Monsanto with Pharmacia Corp. and UpjohnCompany. While at Monsanto, she was a key member of the management team withoversight of financial planning and numerous merger and acquisition transactions.Most recently, Ms. Berland has served as an independent consultant forbiotechnology companies. Ms. Berland has an MBA and a BA in BusinessAdministration from the University of Wisconsin - Milwaukee.

 

*KarenAuditore-Hargreaves, PhD,* was promoted to Chief Operating Officer in May 2003 and wasappointed President in December 2003. Prior thereto, she served as Senior Vice President in charge of Researchand Development (from September 2001) and as Vice President, Research andDevelopment (from May 1999).  Prior tojoining the Company, she was Vice President of Research, at CellPro, Inc., andwas responsible for the development of products for the selection, activationand expansion of human 

 

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hematopoietic cells.  Prior to joining CellPro, Dr. Hargreaves heldresearch management positions with Oculon Corporation, PATH and Genetic SystemsCorporation.  Among others, Dr. Hargreavesholds a PhD in Genetics from the University of California, Davis, and receivedher postdoctoral training at the Massachusetts Institute of Technology Centerfor Cancer Research.

 

*Linda Findlay* was promoted to**VicePresident, Human Resources in September 2001, after joining the Company in May2000 as Director of Human Resources. Previously, she was with DanzasCorporation as Vice President, Human Resources. Prior to Danzas, she was withGenetic Systems, Muzak Limited Partnership, Thousand Trails Inc. and PACCAR,Inc.  Ms. Findlay received a BA inPolitical Science from the University of Washington and an MS in Human ResourceManagement from Seattle Pacific University. She holds a Senior Professional in Human Resources (SPHR) certification.

 

*Anna Lewak Wight, JD,*was promoted to Vice President, Legal and Secretary inSeptember 2001, having served as Director of Intellectual Property sincejoining NeoRx in 1994.  She previouslywas a partner in the law firm of Morrison & Foerster, managing theirSeattle intellectual property practice. Ms. Wight also was a partner in the intellectual property law firm ofHarness, Dickey and Pierce in Michigan, where she established and chaired theBiotechnology and Medical Arts Group. Ms. Wight received a JD from Wayne State University Law School and an MSfrom the Genetics Program at Michigan State University.

 

(c) *Compliance with Section 16(a) of theExchange Act*.  The informationrequired by this item is incorporated herein by reference to the sectioncaptioned “Section 16(a) Beneficial Ownership Compliance” in the Company’sdefinitive Proxy Statement for the 2005 Annual Meeting of Shareholders to beheld June 15, 2005, filed with the Commission pursuant to Section 14(a) ofthe  Exchange Act.

(d) *Code of Ethics.*  Theinformation required by this item is incorporated herein by reference to thesection captioned “Codes of Ethics and Code of Conduct” in the Company’sdefinitive Proxy Statement for the 2005 Annual Meeting of Shareholders to beheld June 15, 2005, filed with the Commission pursuant to Section 14(a) of theExchange Act.

 

***Item 11.  EXECUTIVECOMPENSATION***

 

The informationrequired by this item is incorporated herein by reference to the sectioncaptioned “Executive Compensation” in the Company’s definitive Proxy Statementfor the 2005 Annual Meeting of Shareholders to be held June 15, 2005, filedwith the Commission pursuant to Section 14(a) of the Exchange Act.

 

***Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS***

 

The informationrequired by this item is incorporated herein by reference to the sectionscaptioned “Security Ownership of Certain Beneficial Owners and Management” and“Equity Compensation Plan Information” in the Company’s definitive ProxyStatement for the 2005 Annual Meeting of Shareholders to be held June 15, 2005,filed with the Commission pursuant to Section 14(a) of the Exchange Act.

 

 

***Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS***

 

The informationrequired by this item is incorporated herein by reference to the sectioncaptioned “Certain Relationships and Related Transactions with Management” inthe Company’s definitive Proxy Statement for the 2005 Annual Meeting ofShareholders to be held June 15, 2005, filed with the Commission pursuant toSection 14(a) of the Exchange Act.

 

***Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES***

 

The information required by thisitem is incorporated herein by reference to the section captioned “PrincipalAccounting Feesand Services” in the Company’s definitive Proxy Statement for the 2005 

 

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Annual Meeting of Shareholders tobe held June 15, 2005, filed with the Commission pursuant to Section 14(a) ofthe Exchange Act.

 

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**PART IV**

 

***Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K***

 

(a) (1) FinancialStatements — See Index to Financial Statements.

 

(2) FinancialStatement Schedules — Not applicable.

 

(3) Exhibits — SeeExhibit Index filed herewith.

 

(b) Exhibits — SeeExhibit Index filed herewith.

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

| NEORX CORPORATION       |
|-------------------------|
| (Registrant)            |
|                    |
| /s/ SUSAN D. BERLAND    |
| Susan D. Berland        |
| Chief Financial Officer |
|                    |

Date: March 28, 2005

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and as of the dates indicated:

 
| /s/ GERALD  MCMAHON      | Chairman and Chief Executive Officer | March 28, 2005 |
|--------------------------|--------------------------------------|----------------|
| Gerald McMahon           |                                 |           |
|                     |                                 |           |
| /s/ FRED  B. CRAVES      | Director                             | March 28, 2005 |
| Fred B. Craves           |                                 |           |
|                     |                                 |           |
| /s/ E.  ROLLAND DICKSON  | Director                             | March 28, 2005 |
| E. Rolland Dickson       |                                 |           |
|                     |                                 |           |
| /s/ CARL  S. GOLDFISCHER | Director                             | March 28, 2005 |
| Carl S. Goldfischer      |                                 |           |
|                     |                                 |           |
| /s/ ALAN  A. STEIGROD    | Director                             | March 28, 2005 |
| Alan A. Steigrod         |                                 |           |
|                     |                                 |           |
| /s/ ROBERT  M. LITTAUER  | Director                             | March 28, 2005 |
| Robert M. Littauer       |                                 |           |
|                     |                                 |           |
| /s/ DAVID  R. STEVENS    | Director                             | March 28, 2005 |
| David R. Stevens         |                                 |           |
|                     |                                 |           |
| /s/ ALAN  B. GLASSBERG   | Director                             | March 28, 2005 |
| Alan B. Glassberg        |                                 |           |
|                     |                                 |           |

 

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**EXHIBIT INDEX**

 

** **
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                         | ** ** | ** ** |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 3.1         |       | Amended and Restated Articles of Incorporation                                                                                                                                                                                          |       | (B)        |
| 3.2         |       | Bylaws, as amended                                                                                                                                                                                                                      |       | (K)        |
| 10.1        |       | Restated 1994 Stock Option Plan (‡)                                                                                                                                                                                                |       | (F)        |
| 10.2        |       | Lease Agreement for 410 West Harrison facility, dated March 1,  1996, between NeoRx Corporation and Diamond Parking, Inc.                                                                                                               |       | (H)        |
| 10.3        |       | Amendment No. 1, dated August 14, 2000, to Lease Agreement  between NeoRx Corporation and Dina Corporation                                                                                                                              |       | (J)        |
| 10.4        |       | 1991 Stock Option Plan for Non-Employee Directors, as amended  (‡)                                                                                                                                                                 |       | (E)        |
| 10.5        |       | 1991 Restricted Stock Plan (‡)                                                                                                                                                                                                     |       | (D)        |
| 10.6        |       | Indemnification Agreement (‡)                                                                                                                                                                                                      |       | (H)        |
| 10.7        |       | License Agreement, dated June 30, 1999, between NeoRx and The  Dow Chemical Company. Certain portions of the agreement have been omitted  pursuant to a grant of confidential treatment                                                 |       | (K)        |
| 10.8        |       | Stock Option Agreement, dated December 19, 2000, between NeoRx  Corporation and Carl S. Goldfischer (‡)                                                                                                                            |       | (I)        |
| 10.9        |       | Stock Option Agreement, dated January 17, 2001, between NeoRx  Corporation and Carl S. Goldfischer (‡)                                                                                                                             |       | (I)        |
| 10.10       |       | License Agreement dated as of April 2, 2004, between the Company  and AnorMED, Inc. Certain portions of the agreement have been omitted  pursuant to a request for confidential treatment                                               |       | (Q)        |
| 10.11       |       | Sublicense Agreement, dated May 15, 1997, between NeoRx  Corporation and Roche Molecular Biochemicals. Certain portions of the  agreement have been omitted pursuant to a grant of confidential treatment                               |       | (L)        |
| 10.12       |       | Stock Option Grant Program for Nonemployee Directors under the  NeoRx Corporation 1994 Restated Stock Option Plan (‡)                                                                                                              |       | (M)        |
| 10.13       |       | Facilities Lease, dated February 15, 2002, between NeoRx  Corporation and Selig Real Estate Holdings Six                                                                                                                                |       | (A)        |
| 10.14       |       | Lease Termination/Continuation Agreement dated October 8, 2002,  between NeoRx Corporation and Dina Corporation                                                                                                                         |       | (N)        |
| 10.15       |       | Key Executive Severance Agreement dated as of May 13, 2003,  between the Company and Karen Auditore-Hargreaves (‡)                                                                                                                 |       | (C)        |
| 10.16       |       | Change of Control Agreement dated as of May 13, 2003, between  the Company and Karen Auditore-Hargreaves (‡)                                                                                                                       |       | (C)        |
| 10.17       |       | Key Executive Severance Agreement dated as of February 28, 2003,  between the Company and Linda Findlay (‡)                                                                                                                        |       | (C)        |
| 10.18       |       | Change of Control Agreement dated as of February 28, 2003,  between the Company and Linda Findlay (‡)                                                                                                                              |       | (C)        |
| 10.19       |       | Key Executive Severance Agreement dated as of February 28, 2003,  between the Company and Anna Wight (‡)                                                                                                                           |       | (C)        |
| 10.20       |       | 2004 Incentive Compensation Plan (‡)                                                                                                                                                                                               |       | (P)        |
| 10.21       |       | Supply Agreement dated as of March 1, 2004, between the Company  and the University of Missouri Research Reactor facility group. Certain  portions of the agreement have been omitted pursuant to a request for  confidential treatment |       | (Q)        |
| 10.22       |       | Letter Agreement dated November 4, 2004, extending Supply  Agreement with MURR                                                                                                                                                          |       | (G)        |
| 10.23       |       | Agreement of Sale and Purchase dated as of April 2, 2004,  between the Company and Aletheon Pharmaceuticals, Inc. Certain portions of  the agreement have been omitted pursuant to a request for confidential  treatment                |       | (Q)        |
| 10.24       |       | Key Executive Severance Agreement dated as of May 11, 2004,  between the Company and Jerry McMahon (‡)                                                                                                                             |       | (R)        |
| 10.25       |       | Change of Control Agreement dated as of May 11, 2004, between  the Company and Jerry McMahon (‡)                                                                                                                                   |       | (R)        |
| 10.26       |       | Key Executive Severance Agreement dated as of October 25, 2004,  between the Company and Susan D. Berland (‡)                                                                                                                      |       | (S)        |

 

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| 10.27    |   | Change of Control Agreement dated as of October 25, 2004,  between the Company and Susan D. Berland (‡)                                                                      |   | (S)    |
|----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| 10.28    |   | Form of Non-Qualified Stock Option Agreement under 2004  Incentive Compensation Plan (‡)                                                                                     |   | (O)    |
| 10.29    |   | Form of Incentive Stock Option Agreement under 2004 Incentive  Compensation Plan (‡)                                                                                         |   | (O)    |
| 23       |   | Consent of KPMG LLP                                                                                                                                                               |   | (T)    |
| 31.1     |   | Rule 13a-14(a)/15d-14(a) Certification of Chairman and Chief  Executive Officer                                                                                                   |   | (T)    |
| 31.2     |   | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial  Officer                                                                                                                |   | (T)    |
| 32.1     |   | Section 1350 Certification of Chairman and Chief Executive  Officer                                                                                                               |   | (T)    |
| 32.2     |   | Section 1350 Certification of Chief Financial Officer                                                                                                                             |   | (T)    |
|     |   |                                                                                                                                                                              |   |   |
|          |
| (‡) |   | Management contract or compensatory plan.                                                                                                                                         |   |   |
|     |   |                                                                                                                                                                              |   |   |
|     |   |                                                                                                                                                                              |   |   |
| (A)      |   | Filed as an exhibit to the Company’s Form 10-K for the fiscal  year ended December 31, 2001, and incorporated herein by reference.                                           |
|     |   |                                                                                                                                                                              |   |   |
| (B)      |   | Filed as an exhibit to the Company’s Current Report on Form 8-K  filed March 18, 2005, and incorporated herein by reference.                                                 |
|     |   |                                                                                                                                                                              |   |   |
| (C)      |   | Filed as an exhibit to the Company’s Registration Statement on  Form S-3/-A (Registration No. 333-111344) filed on February 23, 2004, and  incorporated herein by reference. |
|     |   |                                                                                                                                                                              |   |   |
| (D)      |   | Filed as an exhibit to the Company’s Annual Report on Form 10-K  for the fiscal year ended September 30, 1991, and incorporated herein by  reference.                        |
|     |   |                                                                                                                                                                              |   |   |
| (E)      |   | Incorporated by reference to Exhibit A to the Company’s  definitive proxy statement on Schedule 14A filed April 10, 1996.                                                    |
|     |   |                                                                                                                                                                              |
| (F)      |   | Filed as an exhibit to the Company’s Form 10-K for the fiscal  year ended December 31, 1995, and incorporated herein by reference.                                           |
|     |   |                                                                                                                                                                              |   |   |
| (G)      |   | Filed as an exhibit to the Company’s Current Report on Form 8-K  filed February 3, 2005, and incorporated herein by reference.                                               |
|     |   |                                                                                                                                                                              |   |   |
| (H)      |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended March 31, 1996, and incorporated herein by reference.                                         |
|     |   |                                                                                                                                                                              |   |   |
| (I)      |   | Filed as an exhibit to the Company’s Form 10-K for the fiscal  year ended December 31, 2000 and incorporated herein by reference.                                            |
|     |   |                                                                                                                                                                              |   |   |
| (J)      |   | Filed as an exhibit to the Company’s Form 10-K for the fiscal  year ended December 31, 1998, and incorporated herein by reference.                                           |
|     |   |                                                                                                                                                                              |   |   |
| (K)      |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended September 30, 1999, and incorporated herein by reference.                                     |
|     |   |                                                                                                                                                                              |   |   |
| (L)      |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended March 31, 2001, and incorporated herein by reference.                                         |
|     |   |                                                                                                                                                                              |   |   |
| (M)      |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended June 30, 2002, and incorporated herein by reference.                                          |
|     |   |                                                                                                                                                                              |   |   |
| (N)      |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended September 30, 2002,and incorporated herein by reference.                                      |
|     |   |                                                                                                                                                                              |   |   |
| (O)      |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended September 30, 2004,and incorporated herein by reference.                                      |

 

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| (P)    |   | Filed as an exhibit to the Company’s Registration Statement on  Form S-8 (Registration No. 333-115729), filed May 21, 2004, and incorporated  herein by reference. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                    |   |   |
| (Q)    |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended March 31, 2004, and incorporated herein by reference.                               |
|   |   |                                                                                                                                                                    |   |   |
| (R)    |   | Filed as an exhibit to the Company’s Form 10-Q for the quarterly  period ended June 30, 2004, and incorporated herein by reference.                                |
|   |   |                                                                                                                                                                    |   |   |
| (S)    |   | Filed as an exhibit to the Company’s Form 8-K filed October 19,  2004, and incorporated herein by reference.                                                       |
|   |   |                                                                                                                                                                    |
| (T)    |   | Filed herewith.                                                                                                                                                         |

 

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