**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.20549**

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**FORM 10-K**

 

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|                                            |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------------------------------------------------|--------|-------------------------------------------------------------------------------------------|
|                                            |   |                                                                                      |
| **For the fiscal year ended December 31, 2005** |
|                                            |   |                                                                                      |
| **Commission File No. 0-16614**                 |

 

**NEORXCORPORATION**

(Exact nameof Registrant as specified in its charter)

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

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

(Address of principal executive offices)

 

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

 

Securities registered pursuant toSection 12(b) of the Act:

**None**

 

Securities registered pursuant toSection 12(g) of the Act:

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

**$2.4375 ConvertibleExchangeable Preferred Stock, Series 1, $.02 par value**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities

Act.   Yes  o    No  ý

 

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of

the Act. Yes  o    No  ý

 

Indicateby check mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  ý    No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.  ý

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):

 
| Large  accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer ý |
|---------------------------------|--------|--------------------------|--------|-----------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Act). Yes  o    No  ý

 

Theaggregate market value of the voting and non-voting common equity held bynonaffiliates of the registrant was approximately $20.3 million as of June 30,2005, based on a per share closing price of $0.60 on the Nasdaq Capital Marketon that date.

 

As ofFebruary 17, 2006, 34,332,293 shares of the Registrant’s Common Stock, $.02 parvalue per share, were outstanding.

** **

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the Registrant’s ProxyStatement for the Registrant’s 2006 Annual Meeting of Shareholders areincorporated by reference in Part III of this Form 10-K.

 

 

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## **PART I**

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## **IMPORTANTINFORMATION REGARDING FORWARD-LOOKING STATEMENTS**

 

This Form 10-K contains forward-looking statements.  These statements relate to future events orfuture financial performance.  In somecases, you can identify 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 orother terminology.  These statementsreflect our current views with respect to future events and are based onassumptions and are subject to risks and uncertainties.  We discuss many of these risks in greaterdetail under the heading “Risk Factors” in Item 1A. below.  Given these uncertainties, you should notplace undue reliance on these forward-looking statements, which speak only asof the date of this report.

 

You should read this Form 10-K and the documents that we incorporate byreference completely and with the understanding that our actual results,performance and achievements may be materially different from any futureresults, performance or achievements expressed or implied by theforward-looking statements.  We undertakeno obligation to update publicly any forward-looking statements to reflect newinformation, events or circumstances after the date of this report, or toreflect the occurrence of unanticipated events.

 

***Item 1.  BUSINESS***

 

### **The Company**

 

NeoRx is a biotechnology company dedicated to thedevelopment and commercialization of cancer therapy products.  Our current major research and developmentprogram is picoplatin (NX 473), a next generation platinum-based cancer therapydesigned to overcome platinum resistance in the treatment of solid tumors.  We initiated a Phase II clinical study ofpicoplatin in small cell lung cancer in June 2005 and enrolled our firstpatient in July 2005.  As of December 31,2005, we had opened 27 clinical sites in North America, 25 in the United Statesand 2 in Canada, and had enrolled 16 patients on the study.  Subject to the availability of adequatefunds, we currently plan to start a study of picoplatin in patients withmetastatic colorectal cancer in the first half 2006.  In addition to North America and Canada, wealso plan in the first half of 2006 to initiate picoplatin trial sites inEastern Europe, where the greater availability of patients may enable us tomore rapidly increase patient enrollment in our present and proposed trials.

 

Until May 2005, our major research and development program had beenskeletal targeted radiotherapy (STR), a bone-targeting radiotherapeutic.  In May 2005, we announced the immediateimplementation of a strategic restructuring program to refocus our limitedresources on the development of picoplatin. The restructuring plan, which was completed in June 2005, included thediscontinuation of our STR development program, including halting patientenrollment in our Phase III trial of STR in multiple myeloma, ceasingoperations at our Denton, Texas facility, where STR was manufactured, andreducing our workforce by approximately 50%.

 

We recorded restructuring charges against operations totaling $1.7million during the year ended December 31, 2005.  We have evaluated our STR assets in light ofthe restructuring and have determined that a likely impairment exists on thoseassets.  An additional charge of $3.3million against operations was taken in June 2005 to reflect suchimpairment.  Future adjustments to thecharge may be taken as assets involved are sold or otherwise disposed of.  We are actively seeking a buyer for theDenton facility and our STR related assets.

 

Wehave financed our operations primarily through the sale of equity securities,technology licensing, collaborative agreements and debt instruments. We investexcess cash in investment securities that will be used to fund future operatingcosts. Cash, cash equivalents and investment securities, net of restricted cashof $1.0 million, totaled $3.5 million at December 31, 2005 compared to $17.8million at December 31, 2004.  Weprimarily fund current operations with our existing cash and investments.  Cash used to fund operatingactivities for the twelve months ended December 31, 2005 totaled $16.5million.  Revenues and other incomesources for 2005 were not sufficient to cover operating expenses.

 

OnFebruary 1, 2006, we entered into a definitive agreement with institutional andother accredited investors for a $65 million private placement of newly issuedshares of our common stock and the concurrent issuance of warrants for thepurchase of additional shares of common stock. The closing 

 

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ofthe proposed equity financing, including the issuance of the securities and thereceipt of proceeds, is subject to shareholder approval in accordance withNasdaq Marketplace Rules, as well as to satisfaction of customary and otherconditions of closing, including shareholder approval of an amendment to ourarticles of incorporation to increase the number of authorized shares of commonstock in order to provide for a sufficient number of shares to complete thefinancing.  A special meeting ofshareholders to vote on these matters is scheduled to be held on April 11,2006.  If the proposed equity financingis completed, we intend to use the net proceeds to continue to support andexpand the clinical development of picoplatin and pursue our on-going goal ofbuilding a diverse pipeline of oncology products to provide new treatments forcancer patients.  A portion of theproceeds will also be used to retire our outstanding indebtedness to TexasState Bank as described below and for general working capital.

 

Inconnection with the proposed equity financing, we executed a note and warrantpurchase agreement dated as of February 1, 2006, pursuant to which we issuedconvertible promissory notes in favor of the investors in return for ashort-term bridge loan (“bridge loan”) in the aggregate principal amount of$3.46 million.  In addition to the bridgenotes, we issued the investors five-year warrants to purchase an aggregate ofapproximately 2.5 million shares of our common stock at an exercise price of$0.77 per share.  The proceeds of thebridge loan will be used to fund our operations while we seek shareholderapprovals for the proposed equity financing. As a condition to the closing of the bridge loan, we entered into aletter agreement dated January 30, 2006 with Texas State Bank extending theoriginal term of the October 2005 forbearance letter between the Bank and us toJune 5, 2006, and changing the maturity date of our promissory note with theBank to June 5, 2006.  The outstandingbalance of the Bank note at February 17, 2006 was approximately $2.8 million.

 

Sinceour inception in 1984, we have dedicated substantially all of our resources toresearch and development.  We have notgenerated any significant revenue from product sales to date and have operatedat a loss in each year of our existence. We had a net loss of $21.0 million for the year ended December 31, 2005,a net loss of $19.4 million for the year ended December 31, 2004, and a netloss of $5.1 million for the year ended December 31, 2003.  We do not anticipate that our picoplatinproduct candidate, or any other proposed products, will be commercially availablefor several years, if at all. We expect to incur additional operating losses inthe future as we expand our clinical trials and increase our research anddevelopment activities and seek to commercialize picoplatin or other proposedproducts.  Clinical studies areinherently uncertain, and our Phase II trial of picoplatin may not confirm theresults achieved in earlier clinical trials. If picoplatin or any future proposed products are not shown to be safeand effective, we will not receive the required regulatory approvals forcommercial sale of such products. Further, we may not be able to manufacture picoplatin or other proposedproducts in commercial quantities or market such products successfully.

 

Ourconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States, assuming that wewill continue as a going concern. Our total cash, cash equivalents andmarketable securities, net of restricted cash of $1.0 million, was $3.5 millionat December 31, 2005.  With the proceedsfrom the bridge loan, we had cash of $4.7 million at February 17, 2006.  We believe that our current cash and cashequivalent balances, including the proceeds of the bridge loan, will provideadequate resources to fund operations at least until May 31, 2006.  If we do not receive required shareholderapprovals in connection with the proposed equity financing and complete theproposed equity financing in a timely manner, we will not have funds to repaythe bridge notes and the Bank note when they become due and payable or to fundour continuing operations.  In such case,there is a substantial likelihood that we will be forced to explore liquidationalternatives, including seeking protection from creditors under the bankruptcylaws.

 

Seethe discussion in Item 7 below under the heading “Proposed Equity Financing”for a more detailed discussion of the proposed equity financing.

 

*Cancerand its Treatment*

 

Canceris a disease characterized by the uncontrolled growth and spread of abnormalcells.  Cancer cells often originate fromone tissue site and invade, spread and damage other tissue beds and organs,leading to death. The National Institutes of Health estimate that approximately9.8 million individuals in the United States were alive in January 2001 who hadpreviously been diagnosed with cancer.

 

Inrecent years, the diagnosis and treatment of human cancers has greatlyimproved.  However, there is still asubstantial need to improve the diagnosis of early cancer, the staging ofcancer and the 

 

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treatmentof cancer and its metastatic spread.  Itis anticipated that the use of chemotherapeutics and targeted anti-canceragents will be used both as single-agents and in combination to provide benefitto cancer patients.  Often patients aretreated with multiple agents in combination and with different sequencedepending on the particular cancer type and severity of disease.  The oncologist will often assess clinicalbenefit for a particular therapeutic combination by determining the impact oftreatment on tumor size or spread compared to tolerability features.  In this regard, chemotherapeutics havecontinued to have strong impact on cancer treatment, especially when combined withagents that show different anti-cancer properties and different tolerabilityfeatures.  We believe that new treatmentcombinations that incorporate recently approved targeted agents withchemotherapeutics exhibiting improved safety features will be supported byphysicians and their patients.

 

There is considerableneed for new cancer treatments, as well as treatments that provide animprovement to existing therapies. In recent years many new classes of agentsthat provide modest increases in patient survival have been approved foruse.  It is anticipated that the use ofmultiple agents, either in combination or in sequence, will continue to providebenefit to 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 provide 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 generallydestroys cells, and targeted agents which are generally combined with moreconventional chemotherapeutics for maximum effect.  Occasionally, both chemotherapeutics andtargeted agents are used as stand-alone agents in the treatment of humancancers.

** **

**ThePicoplatin Compound**

 

*Picoplatinand Platinum-Based Chemotherapy*

 

InApril 2004, we acquired the rights to develop, manufacture, and commercializepicoplatin (NX 473), a next-generation platinum-based cancer therapeutic.  Platinum-based chemotherapeutics continue tobe widely used since their inception. Platinum-based agents such as cisplatin, carboplatin, and oxaliplatinare currently used to treat a variety of tumors including testicular, ovarian,colorectal and lung.  In this regard,platinum-based chemotherapeutics are administered primarily in combination withother agents, including recently approved targeted cancer agents.  The mechanism that underlies the use ofplatinum-based agents relies upon the targeting of tumor DNA where the platinumcompound binds.  Cells that undergoactive cell division are prevented from completing the cell cycle by thepresence of the platinum drug that is chemically bound to the DNA. The inability to proceed through normal cell division leads to prematuredeath.  In some cases, treatment ofcancer patients leads to reduction in tumor mass due to a higher rate of tumorcell death compared with tumor cell replication.

 

Thecurrent platinum-based chemotherapeutics have specific limitations, includingchemo-resistance and safety side effects. Patients who initially respond to a platinum-containing chemotherapyregime but subsequently progress 90 days or more after chemotherapy have “platinum-sensitive”cancer.  **  **Patients who initially respond toa platinum-containing chemotherapy regimen and then relapse and progress within60 to 90 days after completing chemotherapy are said to have “platinum-resistant”cancer.  Patients who fail to have aresponse or progress during chemotherapy with a platinum-containing regimen aresaid to have “platinum-refractory” cancer. Patients would benefit from aplatinum based agent that can be used initially to prevent the development ofthe platinum refractory or resistant cancer. All platinum-based agents exhibit toxicity to the blood formingcells in the bone marrow (myelosuppression)as a dose-limiting side effect.  The degreeand features of myelosuppression vary with platinum compound, dose andregimen.  In addition, some currentplatinum agents show different degrees of additional safety side effects thatinclude kidney toxicity, hearing loss, nausea, vomiting and peripheral nerve****damage.  As in thecase of myelosuppression, these side effects vary with dose, agent, combinationtherapy and regimen.

 

Newplatinum-based chemotherapeutics that overcome both chemo-resistance and safetylimitations are needed.  Picoplatin hasbeen evaluated in animal models and cancer patients.  In this regard, picoplatin has shown efficacyin both platinum-sensitive and platinum resistant and refractory disease.  Clinical evidence of activity has beenobserved in lung, ovarian, and prostate cancers for picoplatin.  In addition, evaluation of several hundredcancer patients has suggested that picoplatin 

 

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treatmentmay result in less severe and less frequent side effects than observed withsome currently marketed platinum-based agents.

 

*PicoplatinClinical Development*

 

InOctober 2004, we filed an investigational new drug application (IND) with theUS Food and Drug Administration (FDA) to conduct a Phase II clinical trial withpicoplatin versus topotecan in patients with small-cell lung cancer.  This trial was initiated in June 2005 and thefirst patient was treated in July 2005. The objective for patient enrollment is approximately 70 patients withresistant or refractory small cell lung cancer, defined as subjects who either(1) initially responded to first-line platinum-containing chemotherapy and thenrelapsed or progressed within 90 days after completion of first linechemotherapy (resistant disease); or (2) failed or progressed though first lineplatinum-containing chemotherapy (refractory disease).The clinical endpoints ofthe study include safety, objective tumor response rate (tumor shrinkage), timeto tumor progression, and overall survival. The current Phase II trial allows patients to be treated with picoplatinby injection once every three weeks.

 

Weamended our Phase II clinical trial protocol in January 2006 from a two-armstudy of picoplatin versus topotecan to a single arm study of picoplatin.  We discontinued the topotecan arm of thestudy because patients and investigators often were unwilling to accept thetopotecan arm of the two-arm study.  Therationale for the amendment was that the dose and schedule of topotecanapproved for use in patients with “platinum sensitive” small cell lung cancerhave minimal, if any, efficacy in patients with resistant or refractory smallcell lung cancer and unacceptable toxicity, thus presenting a situation inwhich an ineffective but toxic treatment regimen was to be used as one arm ofthe randomized Phase II trial.

 

As of December 31, 2005, we had opened 27 clinicalsites in North America, 25 in the United States and 2 in Canada, and enrolled16 patients on the study.  In addition toNorth America and Canada, we plan in the first half of 2006 to initiatepicoplatin trial sites in Eastern Europe, where the greater availability ofpatients may enable us to more rapidly increase patient enrollment.  We cannot currently predict the length oftime to completion of our Phase II study. Such time to completion will depend upon numerous factors, including ourability to obtain capital to fund the trial, our ability to open clinical sitesand enroll qualified patients into the trial, our ability to obtain adequatesupplies of drug product and to distribute it to the clinical sites on a timelybasis, actions by participating clinicians and clinical institutions andapprovals and other actions by the FDA and other regulatory agencies.

 

To date, we have incurred costs of approximately $4.7million in connection with our picoplatin clinical program. Total estimatedcosts to complete the Phase II trial in small cell lung cancer are in the rangeof $10 million to $12 million for the period through 2007, including the costof drug supply.  The costs could besubstantially higher if we have to repeat, revise, or expand the scope of ourtrial.  These estimated costs exceed ourcurrent capital resources, and we must close the proposed $65 million equityfinancing described in Item 7 below under the heading “Proposed EquityFinancing” and obtain additional funding to complete our picoplatin Phase IItrial.  Moreover, clinical studies areinherently uncertain, and our Phase II trial may not confirm the resultsachieved by others in earlier clinical and pre-clinical studies and may not besupported by the results obtained in subsequent trials.  If picoplatin is not shown to be safe andeffective, we will not be able to obtain the required regulatory approvals forcommercial sale of the product.

 

The FDA has designated picoplatin as an orphan drugfor the treatment of small cell lung cancer under the provisions of the OrphanDrug Act, as amended.  To qualify fororphan drug status, a proposed drug must be intended for use in the treatment ofa condition that affects fewer than 200,000 people in the United States.  Orphan drug status entitles us to exclusivemarketing rights for picoplatin in the United States for seven years followingmarket approval, if any, and qualifies us for research grants to supportclinical studies, tax credits for certain research expenses and an exemptionfrom certain application user fees.  Asdiscussed below in the section entitled “Government Regulation and ProductTesting,” the manufacture and marketing of picoplatin are subject to regulationfor safety, efficacy and quality by the FDA and comparable authorities inforeign countries.

 

*SmallCell Lung Cancer and the Lack of Effective Treatment*

 

Approximately 15% of alllung cancers in the United States is small cell lung cancer.  In about 98% of patients, their small celllung cancer is thought to be caused by cigarette smoking.  According to a 

 

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2004report on cancer statistics, there were approximately 34,700 new small celllung cancer patients in the United States. At the time of small cell lung cancer diagnosis, approximatelytwo-thirds of patients have metastases outside the chest and one-third havelimited disease confined to the chest. Small cell lung cancer consists of two stages: (1) limited, which isdefined as cancer confined to the one side of the chest that can be treatedwith a single area of radiation therapy and (2) extensive, which is defined asdisease involving both sides of the chest and/or obvious spread of the cancerbeyond the chest.  Surgery is only usedfor a very few patients with limited-stage disease.  Radiation therapy plus chemotherapy are thestandard for limited-stage small cell lung cancer.  Treatment with radiation therapy pluschemotherapy can cure a small percentage of limited-stage patients.  Chemotherapy is the standard for extensivedisease.  Although small cell lung canceris highly sensitive to chemotherapy and radiation therapy, most patientsdevelop recurrent cancer.

 

Many chemotherapeutic agentsare used to treat small cell lung cancer patients. Initial (first-line)chemotherapy regimens include etoposide, cisplatin, carboplatin, irinotecan(CPT-11), ifosfamide, cyclophosphamide, vincristine and doxorubicin.  The most commonly used initial chemotherapyregimen is combination etoposide plus cisplatin.  Only etoposide is specifically approved bythe FDA for the initial chemotherapy of small cell lung cancer when used incombination with other approved agents. Eighty percent to 100% of patients with limited disease, and 60% to 80%of patients with extensive disease, have a significant response to radiationplus chemotherapy or combination chemotherapy, respectively.  The median duration of response isapproximately 6 to 8 months.  Mediansurvival from the time of diagnosis for limited-stage and extensive-stagedisease is approximately 14 to 20 months and 8 to 13 months, respectively.

 

Agents used for second-linechemotherapy include ifosfamide, paclitaxel, docetaxel, gemcitabine, topotecan,irinotecan, CAV (cyclophosphamide, doxorubicin and vincristine), etoposide andvinorelbine.  Only topotecan is approvedby the FDA for use as second-line chemotherapy for patients withplatinum-sensitive small cell lung cancer. When small cell lung cancer recursfollowing first-line chemotherapy, the median survival is approximately 4 to 5months.

 

Basedon clinical and preclinical data to date, we believe that picoplatin has thepotential to demonstrate activity in small cell lung cancer patients withplatinum-sensitive or resistant disease. A Phase II study was conducted by a prior licensee during 2001 and 2002to assess the activity and tolerability of the drug when given intravenously asa second line therapy to patients with small cell lung cancer. ** **Two of 13 patients(15.4%) with refractory small cell lung cancer achieved a partial response (adecrease in the size of the tumor or in the extent of cancer in the body) withpicoplatin treatment, and two additional patients (15.4%) achieved stabledisease (no increase or decrease in extent or severity of the cancer).  Overall, 4 of 13 patients (30.8%) withrefractory small cell lung cancer achieved a partial response or stable diseasewith picoplatin treatment. The median survival of all 13 treated patients wasapproximately 6.3 months, significantly longer that that which would beexpected with topotecan.

 

*ProposedPicoplatin Study in Colorectal Cancer*

 

Subject to the availability of adequate funds, we currently plan tostart a study of picoplatin in patients with metastatic colorectal cancer inthe first half 2006.  These trials may beconducted in Eastern Europe as well as in North America.  The proposed trial would evaluate increasingdoses of picoplatin in combination with the chemotherapy agents 5-fluorouraciland leucovorin in patients who have failed a 5-fluorouracil/leucovorinregime.  Endpoints would include safety,objective tumor response rate (tumor shrinkage) and time to tumor progression.

 

*PicoplatinSource of Supply*

 

We have a limited supply of picoplatin drug product that wasmanufactured by a prior licensee in September 2004 and earlier.  The drug product has been demonstrated to bestable for 18 to 24 months from the date of manufacture, which time period isnot sufficient to complete our current and proposed clinical trials ofpicoplatin***.***  We have entered into an agreement withHyaluron, Inc. to manufacture and supply additional picoplatin drug product ona purchase order, fixed fee basis.  Theagreement will continue until April 15, 2010, subject to earlier termination byeither party in the event of an uncured material breach or the liquidation orbankruptcy of the other party.  We mayterminate the agreement if we decide to no longer pursue manufacturing ordistribution of picoplatin. There is no assurance that Hyaluron will be able toprovide sufficient supplies of picoplatin drug product on a timely orcost-effective basis. There are in general relatively few manufacturers andsuppliers of picoplatin drug product.  IfHyaluron or an alternate manufacturer is unable or unwilling to manufacture andprovide drug 

 

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productat a cost and on other terms acceptable to us, we may suffer delays in, or beprevented from, initiating or completing our clinical trials of picoplatin.

 

# **Patents and Proprietary Rights**

 

Ourpolicy is to aggressively protect our proprietary technologies.  We have filed applications for US and foreignpatents on many aspects of our technologies.

 

Wehold an exclusive worldwide (except Japan) license granted from AnorMED, Inc.for the development and commercial sale of picoplatin.  Under that license, we are solely responsiblefor the development and commercialization of picoplatin. AnorMED retains theright to prosecute patent applications and maintain all licensed patents, withus reimbursing such expenses. Under the AnorMED agreement, we have the right tosue any third party infringers of the picoplatin patents in the licensedterritory.  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 our 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 our common stock.These milestones include our successful completion of a picoplatin Phase IIstudy or initiation of a picoplatin Phase III study, submission to the FDA of aNew Drug Application (NDA) for picoplatin, regulatory approval from the FDA ofpicoplatin and the attainment of certain levels of annual net sales ofpicoplatin.  Upon regulatory approval,AnorMED also would receive royalty payments of up to 15% on product sales.  We cannot be certain of the extent of oursuccess, if any, in commercializing picoplatin and attaining establishedmilestones.  We initiated our firstpicoplatin trial, a Phase II study of picoplatin in small cell lung cancer, inJune 2005 and it is unlikely that these milestones will be triggered during2006.  Because we cannot predict thelength of time to complete our Phase II study, the time of initiation andcompletion of a Phase III study or the time of submission of an NDA forpicoplatin, we are unable to predict when such milestones may be triggeredafter 2006. ** ** 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.

 

Ourpicoplatin portfolio includes US and foreign patents and applications licensedfrom AnorMED, which cover the picoplatin product.  With respect to picoplatin, we expect to relyprimarily on US patent number 5,665,771 (expiring February 7, 2016), which islicensed to us by AnorMED, and additional licensed patents expiring in 2016covering picoplatin in the European Union. The FDA also has designated picoplatin as an orphan drug for thetreatment of small cell lung cancer under the provisions of the Orphan DrugAct, which entitles us to exclusive marketing rights for picoplatin in theUnited States for seven years following market approval.

 

Anumber of additional potential avenues exist which may further extend ourpicoplatin patent protection and exclusivity. In the United States, these include The Drug Price and Competition andPatent Term Restoration Act of 1984, commonly referred to as the Hatch-WaxmanAct, which, among other things, generally provides for patent term extensionfor up to five years for an issued patent covering a drug product which hasundergone regulatory review before marketing. In addition, since picoplatin has not been previously approved formarketing in the United States, picoplatin may qualify for new chemical entitydata exclusivity, under which the FDA bans submissions of applications fromcompetitors based on published data or Abbreviated New Drug Applications (ANDA)for a drug containing the same active agent. Certain patent term restorationprocedures and marketing exclusivity rights also may be available forqualifying drug products in the European Union or individual foreigncountries.  We intend to evaluate theavailability of these mechanisms for extending the patent term and marketingexclusivity for picoplatin on an individual regional or country basis.  We cannot be certain that we will besuccessful in any efforts to extend the term of any patent relating topicoplatin or that picoplatin will be granted additional marketing exclusivityrights in the United States or abroad.

 

Risksassociated with the protection of our patents and other proprietarytechnologies are described under the heading “Risk Factors” in Item 1Abelow.  Pending or future applications ofNeoRx or our collaborators will not necessarily result in issued patents.  Moreover, the current patents owned by orlicensed to NeoRx may not provide substantial protection or commercial benefit.  In addition to patent 

 

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protection,we rely upon trade secrets, unpatented proprietary know-how and continuingtechnological innovation to develop and maintain our competitive position.Third parties could acquire or independently develop the same or similartechnology, or our issued patents or those licensed could be circumvented,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.

 

UnderUnited States law, although a patent has a statutory presumption of validity,the issuance of a patent is not conclusive as to validity or as to theenforceable scope of its claims. Accordingly, the patents owned or licensed by us could be invalidated,infringed or designed around by third parties. Also, third parties could obtain patents that we would need to licenseor design around.

 

### **Competition**

 

The competition for development of cancer therapies is substantial.There are numerous competitors developing products to treat the cancersfor which we are seeking to develop products. We initially are focusingclinical development of our picoplatin product candidate on the treatment ofsmall cell lung cancer. Numerous companies, including AstraZeneca PLC, CellTherapeutics, Inc., Exelexis, Inc., ImClone Systems Incorporated, ImmunoGen,Inc., Sanofi-Aventis Group, Inex Pharmaceuticals Corporation, Ipsen Limited,The Menarini Group, OSI Genetics, Inc. and PharmaMar USA, Inc., also aredeveloping and testing therapeutics for small cell lung cancer. Thesetherapeutics include chemotherapy, inhibitors, monoclonal antibodies,antagonists and interferons.  We cannotassure you that we will be able to effectively compete with these or futurethird party product development programs.

 

Many biotechnology companies have corporatepartnership arrangements with large, established companies to support research,development and commercialization efforts of products that may be competitivewith our product candidates.  Further, anumber of established pharmaceutical companies, including GlaxoSmithKline,Novartis AG and Bristol-Myers Squibb Co., are developing proprietarytechnologies or have enhanced their capabilities by entering into arrangementswith, or acquiring, companies with technologies applicable to the treatment ofcancer.  Many of our existing orpotential 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 picoplatin product lesscompetitive, uneconomical or obsolete by influencing the degree by whichtransplantation procedures are used to treat cancer patients.

 

Timing of market introduction and healthcare reform, bothuncertainties, will affect the competitive position of our potential products.We believe that competition among products approved for sale will be based,among other things, on product safety, efficacy, reliability, availability,third-party reimbursement, price and patent protection.

 

**Government Regulation and Product Testing**

 

The manufacture and marketing of our proposed picoplatin product andour research 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 picoplatin 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 pharmaceutical product may be marketed inthe United States include:

 

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

 

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

 

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•                  adequateand well-controlled clinical trials to establish the safety and efficacy of thedrug;

 

•                  thesubmission of a Biologic License Application (BLA) or New Drug Application(NDA) to the FDA; and

 

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

 

In addition to obtaining FDA approval for each product, each domesticdrug manufacturing 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 inspection by the FDA or bycorresponding regulatory agencies in such countries under reciprocal agreementswith the FDA.

 

Preclinical studies include laboratory evaluation of product chemistry andformulation, as well as animal studies, to assess the potential safety andefficacy of the proposed product. Laboratories that comply with the FDA regulations regarding GoodLaboratory Practice must conduct preclinical safety tests.  The results of the preclinical studies aresubmitted to the FDA as part of an IND and are reviewed by the FDA prior tocommencement of clinical trials.  Unlessthe FDA provides comments to an IND, the IND will become effective 30 daysfollowing its receipt by the FDA.  Submissionof an IND does not assure FDA authorization to commence clinical trials.

 

Clinical trials involve the administration of the investigational newdrug to healthy volunteers or to patients under the supervision of a qualifiedprincipal investigator.  Clinical trialsare conducted in accordance with the FDA’s Protection of Human Subjectsregulations and Good Clinical Practices under protocols that detail theobjectives of the study, the parameters to be used to monitor safety and theefficacy criteria to be evaluated. Each protocol must be submitted to the FDAas part of the IND.  Further, eachclinical study must be conducted under the auspices of an independentInstitutional Review Board (IRB) at the institution where the study will beconducted.  The IRB will consider, amongother things, ethical factors, the safety of human subjects and the possibleliability of the institution.

 

Clinical trials are typically conducted in three sequential phases, butthe phases may overlap. 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:

 

•                  determinethe efficacy of the drug for specific, targeted indications;

 

•                  determinedosage tolerance and optimal dosage; and

 

•                  identifypossible adverse effects and safety risks.

 

If a compound is found to have potential activity in a disease orcondition and to have an acceptable safety profile in Phase II clinical trials,Phase III clinical trials are undertaken to further evaluate clinical activityand to further test for safety within an expanded patient population atgeographically dispersed clinical study sites. Often, Phase IV (post-marketing) studies are required by the FDA inorder to gain more data on safety and efficacy with a drug after it hastransitioned into general 

 

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medical practice.  With respectto picoplatin or any proposed products subject to clinicaltrials, there can be no assurance that Phase I, Phase II or Phase III studieswill be completed successfully within any specific time period, if at all.  Clinical studies are inherently uncertain,and our current picoplatin and any other future clinical trials may not confirmthe results achieved in earlier clinical trials.  If picoplatin 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 it is determined thatthe subjects or patients are being exposed to an unacceptable health risk.

 

The results of thepharmaceutical development, preclinical studies and clinical trials aresubmitted to the FDA in the form of a New Drug Application (NDA) for approvalof the marketing and commercial shipment of the drug.  The testing and approval processes are likelyto require substantial cost, time and effort, and there can be no assurance thatany approval will be granted on a timely basis, if at all.  The FDA may deny an NDA if applicableregulatory criteria are not satisfied, may require additional testing orinformation, or may require post-market testing and surveillance to monitor thesafety of the product.  If regulatoryapproval is granted, such approval may entail limitations on the indicated usesfor which the product may be marketed. The FDA may withdraw product approvals if compliance with regulatorystandards is not maintained or if problems occur following initialmarketing.  Among the conditions for NDAapproval is the requirement that the prospective manufacturers’ quality controland manufacturing procedures conform to cGMP regulations.  In complying with standards set forth inthese regulations, manufacturers must continue to expend time, money and effortin the areas of production and quality control to ensure full technicalcompliance.

 

**Employees**

 

InJune 2005, Dr. Karen Auditore-Hargreaves resigned as President and Chief OperatingOfficer of the Company and Linda Findlay was, as part of our strategicrestructuring, terminated as Vice President, Human Resources.  Although Dr. Auditore-Hargreaves and Ms.Findlay were officers of the Company, we did not, at the time of their resignationand termination, consider them key employees in terms of our picoplatin productdevelopment.  The responsibilities of Dr.Auditore-Hargreaves and Ms. Findlay have been reassigned to other members ofmanagement.  We did not experience anymaterial disruptions or delays as a consequence of the resignation andtermination of Dr. Auditore-Hargreaves and Ms. Findlay.

 

As of February 17, 2006, we had 19full-time employees and two part-time employees.  Of these full-timeemployees, three hold PhD degrees, two hold an MD degree, and one holds a JDdegree.  Of the total full-time employees, 10 employees were engaged inresearch and development activities and nine were employed in generaladministration.

 

We considerour relations with employees to be good. None of our employees is covered by acollective bargaining agreement.

 

### **Item 1A.         RISK FACTORS**

 

Inaddition to the other information contained in this report, the followingfactors could affect our actual results and could cause our actual results todiffer materially from those achieved in the past or expressed or implied byour forward-looking statements.

 

**Risks Related to Our Business**

 

**If we are unable to obtain shareholder approval and otherwise completethe proposed $65 million equity financing on or before May 31, 2006, we may beforced to explore liquidation strategies.**

 

OnFebruary 1, 2006, we entered into a definitive agreement with institutional andother accredited investors for a $65 million private placement of newly issuedshares of our common stock and the concurrent issuance of warrants for thepurchase of additional shares of common stock. The closing of the proposed equity financing, including the issuance ofthe securities and the receipt of proceeds, is subject to shareholder approvalin accordance with Nasdaq Marketplace Rules, as well as to satisfaction ofcustomary and other conditions of closing, including shareholder approval of anamendment to our articles of incorporation to increase the number of authorizedshares of common stock in order to provide for a sufficient number of shares tocomplete the financing.  A specialmeeting of shareholders to vote on these matters is scheduled to be held onApril 11, 2006.  If the proposed equityfinancing is completed, we intend to use the net proceeds to continue tosupport and expand the clinical development of 

 

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picoplatinand pursue our on-going goal of building a diverse oncology pipeline ofproducts to provide new treatments for cancer patients.  A portion of the proceeds will also be usedto retire our outstanding indebtedness to Texas State Bank and for generalworking capital.

 

Inconnection with the proposed equity financing, we executed a note and warrantpurchase agreement dated as of February 1, 2006, pursuant to which we issuedconvertible promissory notes in favor of the investors in return for ashort-term bridge loan in the aggregate principal amount of $3.46 million.  In addition to the bridge notes, we issuedthe investors five-year warrants to purchase an aggregate of approximately 2.5million shares of our common stock at an exercise price of $0.77 pershare.  The proceeds of the bridge loanwill be used to fund our operations while we seek shareholder approvalsrelating to the proposed equity financing. As a condition to the closing of the bridge loan, we entered into aletter agreement dated January 30, 2006 with Texas State Bank extending theoriginal term of the October 2005 forbearance letter agreement between the Bankand us to June 5, 2006, and changing the maturity date of our promissory notewith the Bank to June 5, 2006.  Theoutstanding balance of the Bank note at February 17, 2006 was approximately$2.8 million.

 

Ourtotal cash, cash equivalents and marketable securities, net of restricted cashof $1.0 million, was $3.5 million at December 31, 2005.  With the proceeds from the bridge loan, wehad total cash and marketable securities of $4.7 million at February 17,2006.  We believe that our current cashand cash equivalent balances, including the proceeds of the bridge loan, willprovide adequate resources to fund operations at least untilMay 31, 2006.  If we do notreceive required shareholder approvals in connection with the proposed equityfinancing and complete the proposed equity financing in a timely manner, wewill not have funds to repay the bridge notes and the Bank note when theybecome due and payable or to fund our continuing operations.  In such case, there is a substantiallikelihood that we will be forced to explore liquidation alternatives,including seeking protection from creditors under the bankruptcy laws.

 

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

 

We have not been profitable since our formation in 1984. As of December31, 2005, we had an accumulated deficit of $255.8 million. Our net loss for thequarter ended December 31, 2005 was $4.0 million.  We had net losses of $21.0 million for theyear ended December 31, 2005, and $19.4 million for the year ended December 31,2004. These losses resulted principally from costs incurred in our research anddevelopment programs and from our general and administrative activities. Todate, we have been engaged only in research and development activities and havenot generated any significant revenues from product sales. In May 2005, weannounced the discontinuation of our STR (bone-targeted radiotherapeutic)development program as part of a strategic plan to refocus our limitedresources on the development of picoplatin (NX 473), a platinum-based cancertherapy.  We do not anticipate that ourpicoplatin product candidate, or any other proposed products, will becommercially available for several years, if at all. We expect to incuradditional operating losses in the future. These losses may increasesignificantly if we expand clinical development, manufacturing andcommercialization efforts.

 

Our ability to achieve long-term profitability is dependent uponobtaining regulatory approvals for our picoplatin product candidate and anyother proposed products and successfully commercializing our products alone orwith third parties.

 

**We will need to raise additional capital to developand commercialize our product candidates and fund operations**, and our future access to capital isuncertain.

 

It is expensive todevelop cancer therapy products and conduct clinical trials for theseproducts.  We have not generated revenuefrom the commercialization of any product, and we expect to continue to incursubstantial net operating losses and negative cash flows from operations forthe future.  Although there can be noassurance, assuming that we complete the proposed $65 million equity financingdescribed above and in Item 7 below in the section entitled “Proposed EquityFinancing”, we will require substantial additional funding to develop andcommercialize picoplatin and any other proposed products and to fund our futureoperations.

 

Managementis continuously exploring financing alternatives, including:

 

•      raisingadditional capital through the public or private sale of equity or debtsecurities or through the establishment of credit or other funding facilities;and

 

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

 

We may not be ableto obtain the required additional capital or enter into relationships withcorporate partners on a timely basis, on favorable terms, or at all.  The report of our independent registeredpublic accountants issued in connection with our annual report on Form 10-K forthe year ended December 31, 2005 contains a statement expressing substantial doubtregarding our ability to continue as a going concern. 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 fundsby issuing common stock or securities convertible into or exercisable forcommon stock, our shareholders may experience substantial dilution, and newinvestors could have rights superior to current security holders.  If the proposed $65 million equity financingis completed but we are thereafter unable to obtain sufficient additional cashwhen needed, we may be forced to reduce expenses though the delay, reduction orcurtailment of our picoplatin and other development and commercialization activities.

 

Ifthe proposed equity financing is completed, the amount of additional financingwe will require in the future will depend on a number of factors, including:

 

•      the scopeand timing of our picoplatin clinical program and other research and developmentefforts, including the progress and costs of our Phase II trial of picoplatinin small cell lung cancer;

 

•      ourability to obtain clinical supplies of picoplatin drug product in a timely andcost effective manner;

 

•      actionstaken by the FDA and other regulatory authorities;

 

•      thetiming and proceeds from any sale of the Denton facility and assets;

 

•      ouralternatives with respect to the STR assets, including any potentialdisposition or outlicensing alternatives and the timing, amount and type of anyconsideration received and other terms of any such transactions;

 

•      thetiming and amount of any milestone or other payments we might receive from orpay to potential strategic partners;

 

•      ourdegree of success in commercializing picoplatin or any other cancer therapyproduct candidates;

 

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

 

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

 

•      the costsof any research collaborations or strategic partnerships established, if wechooses to pursue such activities; and

 

•      the costsof preparing, filing, prosecuting, maintaining and enforcing patent claims andother intellectual property rights.

 

We have net operating loss carryforwards ofapproximately $138 million, which expire from 2006 through 2025.  If the proposed equity financing iscompleted, a change of control would occur that may limit our ability toutilize these net operating loss carryforwards. If such limitation occurs, we may incur higher tax expense, which alsowould affect our capital requirements.

 

**Our potential products must undergo rigorous clinical testing andregulatory approvals, which could be costly, time consuming, and subject us tounanticipated delays or prevent us from marketing any products.**

 

Themanufacture and marketing of our picoplatin product candidate and our researchand development activities are subject to regulation for safety, efficacy andquality by the FDA in the United States and by comparable authorities in othercountries.

 

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Theprocess of obtaining FDA and other required regulatory approvals, includingforeign approvals, is expensive, often takes many years and can varysubstantially depending on the type, complexity and novelty of the productsinvolved.

 

Wehave had only limited experience in filing and pursuing applications necessaryto gain regulatory approvals. This may impede our ability to obtain timelyapprovals from the FDA or foreign regulatory agencies. We will not be able tocommercialize our product candidates until we obtain regulatory approval, andconsequently any delay in obtaining, or inability to obtain, regulatoryapproval could harm our business.

 

Ifwe violate regulatory requirements at any stage, whether before or aftermarketing approval is obtained, we may be fined, forced to remove a productfrom the market or experience other adverse consequences, including delay,which could materially harm our financial results. Additionally, we may not beable to obtain the labeling claims necessary or desirable for productpromotion. In addition, if we or other parties identify serious side effectsafter any of our products are on the market, or if manufacturing problemsoccur, regulatory approval may be withdrawn and reformulation of our products,additional clinical trials, changes in labeling of our products, and/oradditional marketing applications may be required.

 

Therequirements governing the conduct of clinical trials and manufacturing andmarketing of our proposed products outside the United States vary widely fromcountry to country. Foreign approvals may take longer to obtain than FDAapprovals and can involve additional testing. Foreign regulatory approvalprocesses include all of the risks associated with the FDA approval processes.Also, approval of a product by the FDA does not ensure approval of the sameproduct by the health authorities of other countries.

 

**We may take longer to complete our clinical trials than we project, orwe may be unable to complete them at all.**

 

InJune 2005, we initiated a Phase II clinical trial of picoplatin for thetreatment of patients with small cell lung cancer and enrolled our firstpatient in July 2005.  This trial is arandomized trial comparing picoplatin to topotecan in patients with small celllung cancer who are refractory or resistant to previous platinum-basedtherapy.  Topotecan is an anti-tumor drugcurrently approved by the FDA as a treatment for small cell lung cancersensitive disease after failure of first line chemotherapy.  The endpoints of the picoplatin trial includesurvival, response rate (tumor shrinkage), duration of response and time toprogression.  We amended our Phase II clinicaltrial protocol in January 2006 from a two-arm study of picoplatin versustopotecan to a single arm study of picoplatin. We discontinued the topotecan arm of the study because patients andinvestigators often were unwilling to accept the topotecan arm of the two-armstudy.  The rationale for the amendmentwas that the dose and schedule of topotecan approved for use in patients withplatinum-sensitive small cell lung cancer have minimal, if any, efficacy inpatients with resistant or refractory small cell lung cancer and unacceptabletoxicity, thus presenting a situation in which an ineffective but toxictreatment regimen was to be used as one arm of the randomized Phase II trial.

 

Wealso plan to undertake a Phase I/II trial of picoplatin in colorectal cancer.The proposed trial would evaluate increasing doses of picoplatin in combinationwith the chemotherapy agents 5-fluorouracil and leucovorin in patients who havefailed a 5-fluorouracil/leucovorin chemotherapy regimen. Endpoints wouldinclude safety, response rate (tumor shrinkage), duration of response and timeto progression.  This proposed trialcurrently is targeted to begin in the first half of 2006.

 

Theactual time for initiation and completion of our picoplatin clinical trialsdepend upon numerous factors, including:

 

•      ourability to close the proposed $65 million equity financing described in Item 7below under the heading “Proposed Equity Financing”;

 

•      ourability to obtain adequate additional funding or enter into strategicpartnerships;

 

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

 

•      ourability to open clinical sites;

 

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•      ourability to enroll qualified patients into our studies;

 

•      ourability to obtain sufficient, reliable and affordable supplies of thepicoplatin drug product;

 

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

 

•      theextent of scheduling conflicts with participating clinicians and clinicalinstitutions.

 

Wemay not initiate, advance or complete our picoplatin or any other proposedclinical studies as projected or achieve successful results.

 

Wewill rely on academic institutions and clinical research organizations toconduct, supervise or monitor some or all aspects of clinical trials involvingpicoplatin.  Further, to the extent thatwe now or in the future participate in collaborative arrangements in connectionwith the development and commercialization of our proposed products, we willhave less control over the timing, planning and other aspects of our clinicaltrials. If we fail to initiate, advance or complete, or experience delays in orare forced to curtail our current or planned clinical trials, our stock priceand our ability to conduct our business could be materially negativelyaffected.

 

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

 

Our research and development programs are designed to test the safetyand efficacy of our proposed products in humans through extensive preclinicaland clinical testing. We may experience numerous unforeseen events during, oras a result of, the testing process that could delay or preventcommercialization of picoplatin or any other proposed products, including thefollowing:

 

•      thesafety and efficacy results obtained in early human clinical trials may not beindicative of results obtained in later clinical trials;

 

•      theresults of preclinical studies may be inconclusive, or they may not beindicative of results that will be obtained in human clinical trials;

 

•      afterreviewing test results, we or any potential collaborators may abandon projectsthat we previously believed were promising;

 

•      ourpotential collaborators or regulators may suspend or terminate clinical trialsif the participating subjects or patients are being exposed to unacceptablehealth risks; and

 

•      theeffects of our potential products may not be the desired effects or may includeundesirable side effects or other characteristics that preclude regulatoryapproval or limit their commercial use if approved.

 

Clinicaltesting is very expensive, can take many years, and the outcome is uncertain.The data that we may collect from our picoplatin clinical trials may not besufficient to support regulatory approval of our proposed picoplatin product.The clinical trials of picoplatin and any other proposed products may not beinitiated or completed on schedule, and the FDA or foreign regulatory agenciesmay not ultimately approve any of our product candidates for commercial sale.Our failure to adequately demonstrate the safety and efficacy of a cancertherapy product under development would delay or prevent regulatory approval ofthe product, which would prevent us from marketing the proposed product.

 

**Success in early clinical trials may not be indicative of resultsobtained in later trials.**

 

Results of early preclinical and clinical trials are based on a limitednumber of patients and may, upon review, be revised or negated by authoritiesor by later stage clinical results. Historically, the results from preclinicaltesting and early clinical trials often have not been predictive of resultsobtained in later clinical trials. A number of new drugs and therapeutics haveshown promising results in initial clinical trials, but subsequently failed toestablish sufficient safety and effectiveness data to obtain necessaryregulatory approvals. Data obtained from preclinical and clinical activitiesare subject to varying interpretations, which may delay, limit or preventregulatory approval.

 

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**We are dependent on suppliers for the timely delivery of materials andservices and may experience future interruptions in supply.**

 

Forour picoplatin product candidate to be successful, we need sufficient, reliableand affordable supplies of the picoplatin drug product.  Sources of picoplatin drug product may belimited, and third-party suppliers of picoplatin drug product may beunable to manufacture drug product in amounts and at prices necessary tosuccessfully commercialize our picoplatin product.  Moreover, third-party manufacturers mustcontinuously adhere to current Good Manufacturing Practice (cGMP) regulations enforced by the FDA through itsfacilities inspection program. If the facilities of these manufacturers cannotpass a pre-approval plant inspection, the FDA will not grant a New DrugApplication (NDA) for our proposed products. In complying with cGMP and foreignregulatory requirements, any of our third-party manufacturers will be obligatedto expend time, money and effort in production, record-keeping and qualitycontrol to assure that our products meet applicable specifications and otherrequirements. If any of our third-party manufacturers fails to comply withthese requirements, we may be subject to regulatory action.

 

We have a limited supply of picoplatin drug product that wasmanufactured by a prior licensee in September 2004 and earlier.  The drug product has been demonstrated to bestable for 18 to 24 months from the date of manufacture, which time period isnot sufficient to complete our current and proposed clinical trials ofpicoplatin***.***  We have entered into an agreement withHyaluron, Inc. to manufacture and supply additional picoplatin drug product ona purchase order, fixed fee basis.  Theagreement will continue until April 15, 2010, subject to earlier termination byeither party in the event of an uncured material breach or the liquidation orbankruptcy of the other party.  We mayterminate the agreement if we decide to no longer pursue manufacturing ordistribution of picoplatin. There is no assurance that Hyaluron will be able toprovide sufficient supplies of picoplatin drug product on a timely or cost-effectivebasis.   There are in general relativelyfew manufacturers and suppliers of picoplatin drug product. If Hyaluron or analternate manufacturer is unable or unwilling to manufacture and provide drugproduct at a cost and on other terms acceptable to us, we may suffer delays in,or be prevented from, initiating or completing our clinical trials ofpicoplatin.

 

Inconnection with our product development activities, we rely on third-partycontractors to perform for us, or assist us with, certain specialized services,including drug manufacture and supply, dispensing, distribution and shipping,and clinical trial management. Because these contractors provide specializedservices, their activities and quality of performance may be outside our directcontrol. If these contractors do not perform their obligations in a timelymanner, or if we encounter difficulties with the quality of services we receivefrom these contractors, we may incur additional costs and delays in productdevelopment activities, which could have a material negative effect on ourbusiness.

 

**If the $65 million proposed equity financing is not completed in atimely manner, or at all, we will be unable to pay our current debt obligationswhen they become due.**

 

Inconnection with our 2001 purchase of the radiopharmaceutical manufacturingplant and other assets located in Denton, Texas, we assumed $6.0 millionprincipal amount of restructured debt held by Texas State Bank, McAllen,Texas.  The loan, which matures in June2006, is secured by the assets acquired in the transaction.  The interest rate on the loan was 7.25% onDecember 31, 2005.  The interest rate,which is equal to the bank prime rate and is adjusted on the same date that thebank prime rate changes as reported in the Wall Street Journal, was 7.50% onFebruary 17, 2006.  The loan provides fora maximum annual interest rate of 18%. Principal and interest are payable in monthly installments.  Principal and interest paid on the noteduring the years ended December 31, 2005 and 2004 totaled $601,000 and$486,000, respectively. The fixed monthly payments on the note are recalculatedin April of each year based on the then current bank prime interest rate andoutstanding note balance.  Based on aninterest rate of 7.25% (effective December 31, 2005) and taking into accountthe early payment of $1.0 million in principal under the arrangement describedbelow, the estimated principal balance payable at maturity would be $2.7million.

 

Theterms of the Texas State Bank loan provide that an event of default may bedeemed to occur if we abandon, vacate or discontinue operations on asubstantial portion of the Denton facility or there is a material adversechange in our financial condition, results of operations, business orproperties. If this were to occur, Texas State Bank could declare the entireamount of the loan ($2.8 million at February 17, 2006) due and immediatelypayable.  In such case, our cashresources and assets could be impaired depending on our ability to raise fundsthrough a sale of the Denton facility or other means.  As a result of the restructuring and thedecision to discontinue its STR development program, we have ceased 

 

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manufacturingoperations at the Denton facility and are actively working to sell the facilityand other STR assets. We have listed the Denton facility for sale at a price of$3.3 million.  Any sales of the Dentonfacility or other Denton assets are subject to approval of the Bank.  As of December 31, 2005, we receivedaggregate proceeds of $115,000 from the sale of equipment and otherassets.  These proceeds were applied tothe outstanding principal balance of the loan. There can be no assurance that the Bank will approve the price or otherterms of any offer received by us to buy the Denton facility or other STRassets, or that the sale proceeds, if any, received by us from such sales willbe sufficient to satisfy the outstanding balance of the Bank loan.  In October 2005, we placed $1.0 million in cashin a restricted deposit account with the Bank as additional collateral tosecure the payment of the loan.  Wefurther agreed that if we were unable to obtain at least $15.0 million in newfinancing on or before January 31, 2006, the Bank may apply the $1.0 millioncash deposit to the payment of the last maturing installments on the loan.  In return, the Bank agreed that our cessationof operations at the Denton facility will not be declared an event of defaultunder the loan as long as we continue to pay insurance and taxes on andotherwise maintain the facility. Additionally, the Bank agreed, prior to January 31, 2006, not to declarethe loan in default on the basis that there has been a material adverse changein our financial condition, results of operations, business or properties.

 

Inconnection with the bridge loan from investors described in the paragraphbelow, the Bank agreed to continue its October 2005 forbearance until June 5,2006, in return for our agreement to change the maturity date of the note fromApril 17, 2009 to June 5, 2006.  Pursuantto our October 2005 agreement, the Bank, as of January 31, 2005, applied the$1.0 million cash collateral and all interest accrued thereon to theoutstanding balance of the Bank note. The outstanding balance of the Bank noteat February 17, 2006 was approximately $2.8 million.

 

Incontemplation of the proposed financing transaction described in Item 7 belowunder the heading “Proposed Financing Transaction,” on February 1, 2006, weexecuted convertible promissory notes in the aggregate principal amount of$3.46 million.  In addition to thesebridge notes, we issued five-year bridge warrants to purchase an aggregate ofapproximately 2.5 million shares of common stock at an exercise price of $0.77per share.  The bridge notes have aninterest rate of 8% per annum and, at the closing of the proposed $65 millionequity financing (if such occurs), automatically would convert intoapproximately 4.9 million shares of common stock.  The bridge notes, which are secured by afirst lien on certain of our assets, will mature on the earliest of (i) May 31,2006, (ii) the closing of the proposed equity financing, and (iii) the writtenelection of the holders of 60% in interest of the principal amount of thebridge notes following an event of default under the terms of the bridge notes.At maturity, the bridge notes may be converted into shares of common stock atthe election of the holders, subject to certain limitations.  If the holders do not elect such voluntaryconversion, the principal balance and all accrued and unpaid interest under thebridge notes will, after the maturity date, bear interest at an increased rateof 13% from and after the date of default to the date of payment in full ofsuch unpaid amount.

 

Wecan provide no assurance that our shareholders will approve the proposed $65million equity financing and that we will be able to satisfy the otherconditions for closing of the proposed equity financing on a timely basis, orat all.  If we do not receive requiredshareholder approvals and complete the proposed equity financing, we will nothave funds to repay the bridge notes and the Bank note when they become due andpayable.  In such case, there is asubstantial likelihood that we will be forced to explore liquidationalternatives, including seeking protection from creditors under the bankruptcylaws.

 

**If wecannot negotiate and maintain collaborative arrangements with third parties,our research, development, manufacturing, sales and marketing activities maynot be cost-effective or successful.**

 

Oursuccess will depend in significant part on our ability to attract and maintaincollaborative partners and strategic relationships to support the development,sale, marketing, distribution and manufacture of picoplatin and any otherfuture product candidates and technologies in the US and Europe.  At present, our only material collaborativeagreement is the exclusive worldwide (except Japan) license granted to us byAnorMED, Inc. for the development and commercial sale of picoplatin.  Under that license, we are solely responsiblefor the development and commercialization of picoplatin. AnorMED retains theright, at our cost, to prosecute patent applications and maintain all patents.  The parties executed the license agreement inApril 2004, at which time we paid AnorMED a one-time upfront milestone paymentof $1.0 million in NeoRx common stock and $1.0 million in cash.  The agreement also provides for additionalmilestone payments to AnorMED of up to $13.0 million, payable in cash or acombination of cash and NeoRx common stock. These milestones include oursuccessful completion of a picoplatin Phase II study or initiation of apicoplatin Phase III study, submission to the FDA of a New Drug 

 

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Application(NDA) for picoplatin, regulatory approval from the FDA of picoplatin and theattainment of certain levels of annual net sales of picoplatin. Upon regulatoryapproval, AnorMED also would receive royalty payments of up to 15% on productsales.  We cannot be certain of theextent of our success, if any, in commercializing picoplatin and attainingestablished milestones.  We initiated ourfirst picoplatin trial, a Phase II study of picoplatin in small cell lungcancer, in June 2005, and it is unlikely that these milestones will betriggered during 2006.  Because we cannotpredict the length of time to complete our Phase II study, the time ofinitiation and completion of a Phase III study or the time of submission of anNDA for picoplatin, we are unable to predict when such milestones may betriggered after 2006.  Because we cannotpredict the length of time to completion of our Phase II study, the time ofinitiation and completion of a Phase III study or the time of submission of anNDA for picoplatin, we are unable to predict when such milestones might betriggered after 2006.  The licenseagreement may be terminated by either party for breach if the other party filesa petition in bankruptcy or insolvency or for reorganization or is dissolved,liquidated or makes assignment for the benefit of creditors. We can terminatethe license at any time upon prior written notice to AnorMED. If not earlierterminated, the license agreement will continue in effect, in each country in theterritory in which the licensed product is sold or manufactured, until theearlier of (i) expiration of the last valid claim of a pending or issued patentcovering the licensed product in that country or (ii) a specified number ofyears after first commercial sale of the licensed product in that country.   If AnorMED were to breach its obligationsunder the license, or if the license expires or is terminated and we cannotrenew, replace, extend or preserve our rights under the license agreement, wewould be unable to move forward with our current and planned picoplatinclinical studies.

 

OnAugust 4, 2005, we entered into a research funding and option agreement withThe Scripps Research Institute (TSRI). This collaboration is still at very early stage. Under the agreement, wewill provide TSRI an aggregate of $2.5 million over a 26-month period to fundresearch relating to synthesis and evaluation of novel small molecule,multi-targeted protein kinase inhibitors as therapeutic agents, including forthe treatment of cancer.  We have theoption to negotiate a worldwide exclusive license to use, enhance and developany compounds arising from the collaboration. The research funding is payable by us to TSRI quarterly in accordancewith a negotiated budget.  We made aninitial funding payment to TSRI of $137,500, on August 8, 2005.  The agreement provides for additionalaggregate funding payments of $1.0 million and $1.4 million in 2006 and 2007,respectively.  We have no assurance thatthe research funded under this arrangement will be successful or ultimatelywill give rise to any viable product candidates. Further, there can be noassurance that we will be able to negotiate, on acceptable terms, a licensewith respect to some or all of the compounds arising from the collaboration.

 

Noneof our current employees has experience selling, marketing and distributingtherapeutic products. To the extent we are successful in obtaining approval forthe commercial sale of picoplatin or any other product candidate; we may needto secure one or more corporate partners to conduct these activities. We maynot be able to enter into partnering arrangements in a timely manner or onterms acceptable to us. To the extent that we enter into co-promotion or otherlicensing arrangements, our product revenues are likely to be lower than if wedirectly marketed and sold our products, and any revenues we receive woulddepend upon the efforts of third parties, which efforts may not be successful.If we are not able to secure adequate partnering arrangements, we would have tohire additional employees or consultants with expertise in sales, marketing anddistribution. Employees with relevant skills may not be available to us.Additionally, any increase in the number of employees would increase ourexpense level and could have a material adverse effect on our financialposition.

 

**We face substantial competition in the development of cancer therapiesand may not be able to compete successfully, and our potential products may berendered obsolete by rapid technological change.**

 

The competition for development of cancer therapies is substantial.There are numerous competitors developing products to treat the cancers forwhich we are seeking to develop products. Our initial focus for picoplatin is small cell lung cancer, a diseasefor which there currently are limited effective therapeutic options. Numerouscompanies, including AstraZeneca PLC, Cell Therapeutics, Inc., Exelexis, Inc.,ImClone Systems 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 thatwe will be able to effectively compete with these or future third party productdevelopment programs. Many of our existing or potential competitors have, orhave access to, substantially greater financial, research and development,marketing and production resources than we do and may be better equipped thanwe are to develop, manufacture and market competing products.  Further, our competitors may have, or may 

 

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developand introduce, new products that would render our picoplatin or any otherproposed product candidates less competitive, uneconomical or obsolete.

 

**If we are unable to protect our proprietary rights, we may not be ableto compete effectively, or operate profitably.**

 

Our success is dependent in part on obtaining, maintaining andenforcing our patents and other proprietary rights and our ability to avoidinfringing the proprietary rights of others. The United States Patent and Trademark Office, or the USPTO, may notissue patents from the patent applications owned by or licensed to us. Ifissued, the patents may not give us an advantage over competitors with similartechnologies.

 

The issuance of a patent is not conclusive as to its validity orenforceability and it is uncertain how much protection, if any, will be givento our patents if we attempt to enforce them and they are challenged in courtor in other proceedings, such as oppositions, which may be brought in foreignjurisdictions to challenge the validity of a patent. A third party maychallenge the validity or enforceability of a patent after its issuance by theUSPTO. It is possible that a competitor may successfully challenge our patentsor that a challenge will result in limiting their coverage. Moreover, the costof litigation to uphold the validity of patents and to prevent infringement canbe substantial. If the outcome of litigation is adverse to us, third partiesmay be able to use our patented invention without payment to us. Moreover, itis possible that competitors may infringe our patents or successfully avoidthem through design innovation. We may need to file lawsuits to stop theseactivities. These lawsuits can be expensive and would consume time and other resources,even if we were successful in stopping the violation of our patent rights. Inaddition, there is a risk that a court would decide that our patents are notvalid and that 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.

 

Inaddition, the protection afforded by issued patents is limited in duration.With respect to picoplatin, in the United States we expect to rely primarily onUS Patent Number 5,665,771 (expiring February 7, 2016), which is licensed to usby AnorMED, and additional licensed patents expiring in 2016 coveringpicoplatin in the European Union.  TheFDA has also designated picoplatin as an orphan drug for the treatment of smallcell lung cancer under the provisions of the Orphan Drug Act, which entitles usto exclusive marketing rights for picoplatin in the United States for seven yearsfollowing market approval.  We may also be able to rely on theHatch-Waxman Act to extend the term of a US patent covering picoplatin afterregulatory approval, if any, of such product in the US.

 

Under our license agreement with AnorMED, AnorMED retains the right toprosecute patent applications and maintain all licensed patents, with NeoRxreimbursing such expenses. Under the AnorMED agreement, we have the right tosue any third party infringers of the picoplatin patents in the licensedterritory (worldwide except Japan). If we do not file suit, AnorMED, in itssole discretion, has the right to sue the infringer at its expense.

 

In addition to the intellectual property rights described above, werely on unpatented technology, trade secrets and confidential information.Therefore, others may independently develop substantially equivalentinformation and techniques or otherwise gain access to or disclose ourtechnology. We may not be able to effectively protect our rights in unpatentedtechnology, trade secrets and confidential information. We require each of ouremployees, consultants and advisors to execute a confidentiality agreement atthe commencement of an employment or consulting relationship with us.  However, these agreements may not provide effectiveprotection of our information or, in the event of unauthorized use ordisclosure, may not provide adequate remedies.

 

**The use of our technologies could potentially conflict with the rightsof others.**

 

Our competitors or others may have or may acquire patent rights thatthey could enforce against us. In such case, we may be required to alter ourproducts, pay licensing fees or cease activities. If our products conflict withpatent rights of others, third parties could bring legal actions against us claimingdamages and seeking to enjoin manufacturing and marketing of the affectedproducts. If these legal actions are successful, in addition to any potentialliability for damages, we could be required to obtain a license in order tocontinue to manufacture or market the affected products. We may not prevail inany legal action and a required license under the patent may not be availableon acceptable terms.

 

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**We may incur substantial costs as a result of litigation or otherproceedings relating to patent and other intellectual property rights.**

 

The cost to us of any litigation or other proceedings relating tointellectual property rights, even if resolved in our favor, could besubstantial. Some of our competitors may be better able to sustain the costs ofcomplex patent litigation because they have substantially greater resources. Ifthere is litigation against us, we may not be able to continue our operations.If third parties file patent applications, or are issued patents claimingtechnology also claimed by us in pending applications, we may be required toparticipate in interference proceedings in the USPTO to determine priority ofinvention. We may be required to participate in interference proceedingsinvolving our issued patents and pending applications. We may be required tocease using the technology or license rights from prevailing third parties as aresult of an unfavorable outcome in an interference proceeding. A prevailingparty in that case may not offer us a license on commercially acceptable terms.

 

InApril 2003, we received $10 million from the sale to Boston ScientificCorporation, or BSC, of certain non-core patents and patent applications andthe grant to BSC of exclusive license rights to certain patents and patentapplications.  BSC originally assertedfour such patents in two lawsuits against Johnson & Johnson, Inc., itssubsidiary, Cordis Corporation, and Guidant Corporation, alleging infringementof such patents.  In both lawsuits, thedefendants denied infringement and asserted invalidity and unenforceability ofthe patents.  BSC subsequently withdrewthree of the patents from the litigation, including the patents that wereassigned to BSC. We understand that BSC is still asserting a licensed patentagainst the defendants, but has also agreed, in principle, to purchaseGuidant.  Although we are not currently aparty to the lawsuits, our management and counsel have been deposed inconnection with the lawsuits.  It ispossible that BSC, if it is unsuccessful or has limited success with itsclaims, may seek damages from us, including recovery of all or a portion of theamounts it paid to us in 2003.  We cannotassess the likelihood of whether such claim will be brought against us or the extentof recovery, if any, on any such claim.

 

**Product liability claims in excess of the amount of our insurance wouldadversely affect our financial condition.**

 

The testing, manufacturing, marketing and sale of picoplatin and anyother proposed cancer therapy products, including past clinical andmanufacturing activities in connection with our terminated STRradiotherapeutic, may subject us to product liability claims. We are insuredagainst such risks up to a $10 million annual aggregate limit in connectionwith clinical trials of our products under development and intend to obtainproduct liability coverage in the future. However, insurance coverage may notbe 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 hazardous materials exposes us to therisk of material environmental liabilities, and we may incur significantadditional costs to comply with environmental laws in the future.**

 

Our research and development and manufacturing processes, as well asthe manufacturing processes that may be used by our collaborators, involve thecontrolled use of hazardous and radioactive materials. As a result, we aresubject to foreign, federal, state and local laws, rules, regulations andpolicies governing the use, generation, manufacture, storage, air emission,effluent discharge, handling and disposal of certain materials and wastes inconnection with our use of these materials. Although we believe that our safetyprocedures for handling and disposing of such materials comply with thestandards prescribed by such laws and regulations, we may be required to incursignificant costs to comply with environmental and health and safetyregulations in the future. In the event that we discontinue operations infacilities that have had past research and manufacturing processes wherehazardous or radioactive materials have been in use, we may have significantdecommissioning costs associated with the termination of operation of thesefacilities. These potential decommissioning costs also may reduce the marketvalue of the facilities and may limit our ability to sell or otherwise disposeof these facilities in a timely and cost-effective manner.  We have terminated our STR manufacturingoperations in Denton, Texas and are actively marketing the facility for sale.  In 2005, we recorded costs associated withthe closure of the Denton facility, including decommissioning costs, of $0.9million.  We estimate costs in 2006related to these activities at $0.1 million. These costs could increase substantially, depending on 

 

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actionsof regulators or if we discover previously unknown contamination in or aroundthe facility.  In addition, the risk ofaccidental contamination or injury from hazardous or radioactive materialscannot be completely eliminated. In the event of such an accident, we could beheld liable for any resulting damages, and any such liability could exceed ourresources. Our current insurance does not cover liability for the clean-upof hazardous waste materials or other environmental risks.

 

**Even if we bring products to market, changes in healthcarereimbursement could adversely affect our ability to effectively price ourproducts or obtain adequate reimbursement for sales of our products.**

 

Potentialsales of our products may be affected by the availability of reimbursement fromgovernments or other third parties, such as insurance companies. It isdifficult to predict the reimbursement status of newly approved, novel medicalproducts. In addition, third-party payors are increasingly challenging theprices charged for medical products and services. If we succeed in bringing oneor more products to market, we cannot be certain that these products will beconsidered cost-effective and that reimbursement to the consumer will beavailable or will be sufficient to allow us to competitively or profitably sellour products.

 

Thelevels of revenues and profitability of biotechnology companies may be affectedby the continuing efforts of government and third-party payors to contain orreduce the costs of healthcare through various means. For example, in certainforeign markets, pricing or profitability of prescription pharmaceuticals issubject to governmental control. In the United States, there have been, and weexpect that there will continue to be, a number of federal and state proposalsto implement similar governmental controls. It is uncertain what legislativeproposals will be adopted or what actions federal, state or private payors forhealth care goods and services may take in response to any health care reformproposals or legislation. Even in the absence of statutory change, marketforces are changing the health care sector. We cannot predict the effect healthcare reforms 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 affect our operations.**

 

InJune 2005, Dr. Karen Auditore-Hargreaves resigned as President and ChiefOperating Officer of the Company and Linda Findlay was, as part of ourstrategic restructuring, terminated as Vice President, Human Resources.  Although Dr. Auditore-Hargreaves and Ms.Findlay were officers of the Company, we did not, at the time of theirresignation and termination, consider them key employees in terms of ourpicoplatin product development.  Theresponsibilities of Dr. Auditore-Hargreaves and Ms. Findlay have beenreassigned to other members of management. We did not experience any material disruptions or delays as aconsequence of the resignation and termination of Dr. Auditore-Hargreaves andMs. Findlay.

 

Asof December 31, 2005, we had a total work force of 21 full-time employees and 2part-time employees.  Our successdepends, to a significant extent, on the continued contributions of ourprincipal management and scientific personnel participating in our picoplatindevelopment program.  We have limited orno redundancy of personnel in key development areas, including finance, legal,clinical operations, regulatory affairs and quality control and assurance. Theloss of the services of one or more of our employees could delay our picoplatinproduct development activities or any other proposed programs and research anddevelopment efforts. We do not maintain key-person life insurance on any of ourofficers, employees or consultants.

 

Competitionfor qualified employees among companies in the biotechnology andbiopharmaceutical industry is intense. Our future success depends upon ourability to attract, retain and motivate highly skilled employees andconsultants. In order to commercialize our proposed products successfully, wewill in the future be required to substantially expand our workforce,particularly in the areas of manufacturing, clinical trials management, regulatoryaffairs, business development and sales and marketing. These activities willrequire the addition of new personnel, including management, and thedevelopment of additional expertise by existing management personnel.  Our current financial situation may make itdifficult to attract and retain key employees.

 

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Wehave change in control agreements and severance agreements with all of ourexecutive officers and consulting agreements with various of our scientificadvisors. Our agreements with our executive officers provide for “at will”employment, which means that each executive may terminate his or her servicewith us at any time. In addition, our scientific advisors may terminate theirservices to us at any time.

 

**Risks Related to Our Common Stock**

 

**Our common stock may be delisted from The Nasdaq CapitalMarket if we are unable to maintain compliance with Nasdaq Capital Marketcontinued listing requirements.**

 

Ourcommon stock listing was transferred from The Nasdaq National Market to TheNasdaq Capital Market (formerly the Nasdaq SmallCap Market) on March 20,2003. We elected to seek a transfer to The Nasdaq Capital Market because we hadbeen unable to regain compliance with The Nasdaq National Market minimum $1.00bid price requirement for continued listing. By transferring to The NasdaqCapital Market, we were afforded an extended grace period in which to satisfyThe Nasdaq Capital Market $1.00 minimum bid price requirement.  On May 6, 2003, we received notice fromNasdaq confirming that we were in compliance with the $1.00 minimum bid pricerequirement. We will not be eligible to relist our common stock on The NasdaqNational Market unless and until our common stock maintains a minimum bid priceof $5.00 per share for 90 consecutive trading days and we otherwise comply withthe initial listing requirements for The Nasdaq National Market. Trading on theNasdaq Capital Market may have a negative impact on the value of our commonstock, because securities trading on the Nasdaq Capital Market typically areless liquid than those traded on The Nasdaq National Market.

 

On January 10, 2006, we received a notice from Nasdaq indicating thatwe are not in compliance with Nasdaq Marketplace Rule 4310(c)(8)(D) (theMinimum Bid Price Rule) because the closing bid price of our common stock hadbeen below $1.00 per share for 30 consecutive trading days.  In accordance with Nasdaq Marketplace Rules,we were provided 180 calendar days, or until, July 10, 2006, to regain compliancewith the Minimum Bid Price Rule.  Toregain compliance, the closing bid price of our common stock had to remain at$1.00 per share or more for a minimum of ten consecutive trading days.  On February 22, 2006, we received a noticefrom Nasdaq indicating that we had regained compliance with the Minimum BidPrice Rule.  The closing bid price of ourcommon stock may in the future fall below the Minimum Bid Price Rule or we mayin the future fail to meet other requirements for continued listing on theNasdaq Capital Market.  If we are unableto cure any future events of noncompliance in a timely or effective manner, ourcommon stock could be delisted from the Nasdaq Capital Market

 

If our common stock were to be delisted from The Nasdaq Capital Market,we may seek quotation on a regional stock exchange, if available. Such listingcould reduce the market liquidity for our common stock. If our common stock isnot eligible for quotation on another market or exchange, trading of our commonstock could be conducted in the over-the-counter market on an electronicbulletin board established for unlisted securities such as the Pink Sheets orthe OTC Bulletin Board. As a result, an investor would find it more difficultto dispose of, or obtain accurate quotations for the price of, our commonstock.

 

Ifour common stock were to be delisted from The Nasdaq Capital Market, and ourtrading price remains below $5.00 per share, trading in our common stock mightalso become subject to the requirements of certain rules promulgated under theSecurities Exchange Act of 1934, which require additional disclosure by broker-dealersin connection with any trade involving a stock defined as a “penny stock”(generally, any equity security not listed on a national securities exchange orquoted on Nasdaq that has a market price of less than $5.00 per share, subjectto certain exceptions). Many brokerage firms are reluctant to recommendlow-priced stocks to their clients. Moreover, various regulations and policiesrestrict the ability of shareholders to borrow against or “margin” low-pricedstocks, and declines in the stock price below certain levels may triggerunexpected margin calls. Additionally, because brokers’ commissions onlow-priced stocks generally represent a higher percentage of the stock pricethan commissions on higher priced stocks, the current price of the common stockcan result in an individual shareholder paying transaction costs that representa higher percentage of total share value than would be the case if our shareprice were higher. This factor may also limit the willingness of institutionsto purchase our common stock. Finally, the additional burdens imposed uponbroker-dealers by these requirements could discourage broker-dealersfrom facilitating trades in our common stock, which could severely limit themarket liquidity of the stock and the ability of investors to trade our commonstock.

 

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**Our stock price is volatile and, as a result, you could losesome or all of your investment.**

 

There has been a history of significant volatility in the market pricesof securities of biotechnology companies, including our common stock. In 2005,the high and low closing sale prices of our common stock were $2.34 and $0.47.  In 2004, the high and low closing sale priceswere $5.78 and $1.43.  Our stock pricehas been and may continue to be affected by this type of market volatility, aswell as our own performance. Our business and the relative price of our commonstock may be influenced by a large variety of factors, including:

 

•      announcementsby us or our competitors concerning acquisitions, strategic alliances,technological innovations, new commercial products or changes in productdevelopment strategies;

 

•      theavailability of critical materials used in developing our proposed picoplatinproduct;

 

•      ourability to conduct our picoplatin clinical development program on a timely andcost-effective basis and the progress and results of our clinical trials andthose of our competitors;

 

•      developmentsconcerning patents, proprietary rights and potential infringement;

 

•      developmentsconcerning potential agreements with collaborators;

 

•      theexpense and time associated with, and the extent of our ultimate success in,securing regulatory approvals;

 

•      ouravailable cash or other sources of funding; and

 

•      futuresales of significant amounts of our common stock by us or our shareholders.

 

In addition, potential public concern about the safety of our proposedpicoplatin product and any other products we develop, comments by securitiesanalysts, our ability to maintain the listing of our common stock on the Nasdaqsystem, and conditions in the capital markets in general and in the lifescience capital market specifically, may have a significant effect on themarket price of our common stock. The realization of any of the risks describedin this report, as well as other factors, could have a material adverse impacton the market price of our common stock and may result in a loss of some or allof your investment in our securities.

 

In the past, securities class action litigation often has been broughtagainst companies following periods of volatility in their stock prices. We mayin the future be the target of similar litigation. Securities litigation couldresult in substantial costs and divert our management’s time and resources,which could cause our business to suffer.

 

**Certain provisions in our articles of incorporation andWashington state law could discourage a change of control.**

 

Our articles of incorporation authorize our board of directors to issueup to 150,000,000 shares of common stock and up to 3,000,000 shares ofpreferred stock.  With respect topreferred stock, our board has the authority to determine the price, rights,preference, privileges and restrictions, including voting rights, of thoseshares without any further vote or action by our shareholders.  In order to effectuate the proposed $65million equity financing described in Item 7 below under the heading “ProposedEquity Financing,” we will be seeking shareholder approval at the specialmeeting of shareholders to be held April 11, 2006 to increase our authorizedcommon stock to 200,000,000.

 

We have adopted a shareholder rights plan, which is intended to protectthe rights of shareholders by deterring coercive or unfair takeover tactics.The board of directors declared a dividend to holders of our common stock ofone preferred share purchase right for each outstanding share of common stock.In addition, under certain circumstances, holders of our Series BConvertible Preferred Stock are entitled to receive one preferred sharepurchase right for each share of common stock into which their Series Bpreferred stock may be converted. The rights are exercisable ten days followingthe offer to purchase or acquisition of beneficial ownership of 20% of theoutstanding common stock by a person or group of affiliated persons. Each rightentitles the registered holder, other than the acquiring 

 

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personor group, to purchase from NeoRx one-hundredth of one share of Series AJunior Participating Preferred Stock at the price of $40, subject toadjustment. The rights expire April 10, 2006. In lieu of exercising theright by purchasing one one-hundredth of one share of Series A preferredstock, the holder of the right, other than the acquiring person or group, maypurchase for $40 that number of shares of our common stock having a marketvalue of twice that price.

 

Washington law imposes restrictions on certain transactions between acorporation and significant shareholders. Chapter 23B.19 of the WashingtonBusiness Corporation Act prohibits a target corporation, with some exceptions,from engaging in particular significant business transactions with an acquiringperson, which is defined as a person or group of persons that beneficially owns10% or more of the voting securities of the target corporation, for a period offive years after the acquisition, unless the transaction or acquisition ofshares is approved by a majority of the members of the target corporation’sboard of directors prior to the acquisition. Prohibited transactions include, among other things:

 

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

 

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

 

•      receiptby the acquiring person of any disproportionate benefit as a shareholder.

 

A corporation may not opt out of this statute. This provision may havethe effect of delaying, deterring or preventing a change in control of NeoRx orlimiting future investment in NeoRx by significant shareholders and theiraffiliates and associates.

 

The provisions of our articles of incorporation, shareholder rightsplan and Washington law discussed above may have the effect of delaying,deterring or preventing a change of control of NeoRx, even if this change wouldbe beneficial to our shareholders. These provisions also may discourage bids forour common stock at a premium over market price and may adversely affect themarket price of, and the voting and other rights of the holders of, our commonstock. In addition, these provisions could make it more difficult to replace orremove our current directors and management in the event our shareholdersbelieve this would be in the best interests of the corporation and ourshareholders.

 

**Certain provisions of our Series B Convertible PreferredStock and certain outstanding warrants may prevent or make it more difficultfor us to raise funds or take other actions.**

 

Certain provisions of the Preferred Stock and Warrant PurchaseAgreement and Certificate of Designation for our Series B ConvertiblePreferred Stock may require us to obtain the approval of the holders ofSeries B preferred stock to amend, alter or repeal any provision of theCertificate of Designation which may be deemed to materially adversely affectthe rights of the holders of Series B preferred stock or to authorize,create or issue any class or series of securities having liquidation or otherrights superior to those of the Series B preferred stock. TheSeries B preferred stock also contains provisions requiring the adjustmentof the conversion price if we issue (other than in connection with certainpermitted transactions, such as strategic collaborations and acquisitionsapproved by the board of directors or transactions approved by a majority ofthe holders of the Series B preferred stock) shares of common stock atprices 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. Similar antidilutionprovisions are contained in common stock warrants issued to investors inconnection with our 2004 and 2005 private placement transactions.  These provisions may make it more difficultfor our management or shareholders to take certain corporate actions and coulddelay, discourage or prevent future financings. These provisions could alsolimit the price that certain investors might be willing to pay for shares ofour common stock.

 

Theoutstanding shares of Series B preferred stock were convertible into 3,446,389shares of common stock as of December 31, 2005. On February 1, 2006, the holders of all outstanding shares of ourSeries B preferred stock entered into an agreement to convert their Series Bpreferred shares upon closing, if any, of the equity financing described underthe heading “Proposed Equity Financing” below.  If the proposed equityfinancing is completed, the outstanding shares of Series B preferred stock willbe converted into an aggregate of approximately 9.5 million shares of commonstock, and the Series B preferred shares so converted will be retired andcancelled and not reissued.

 

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**If we complete the proposed $65 million equity financing, thenumber of shares of our common stock outstanding will increase substantiallyand certain investors will beneficially own significant blocks of our commonstock; upon registration, such common shares will be generally available forresale in the public market.**

 

Ifthe proposed $65 million equity financing described in Item 7 below under theheading “Proposed Equity Financing” is completed, we will issue to a smallgroup of institutional and other accredited investors an aggregate ofapproximately 92.9 million shares of common stock (which amount includes sharesissued upon automatic conversion of the bridge notes), plus warrants topurchase an aggregate of approximately 25.4 million additional shares of commonstock.  These investors also havereceived warrants to purchase an aggregate of approximately 2.5 million shares of common stock inconnection with their participation in the bridge loan.  Concurrently with the closing, weadditionally would issue an aggregate of approximately 9.5 million shares ofcommon stock to the holders of our Series B preferred stock upon conversion oftheir Series B preferred shares.  Theissuance of such shares and warrants would have a substantial dilutive effecton shareholders who acquired our common stock prior to the closing of the proposedequity financing.

 

Theproposed equity financing is being led by MPM Capital.  Upon closing of the proposed equity financing(assuming shareholder approval), MPM Capital would become the beneficial ownerof approximately 30% of our common stock and would have representation on ourboard of directors, filling one of two new director positions to be created inconnection with the financing.  Thesecond new director position would be filled by a representative selected bymutual agreement of MPM Capital and Bay City Capital.  Bay City Capital would acquire beneficialownership of approximately 16% of our common stock upon closing of the proposedequity financing.  Two of our currentdirectors, Dr. Fred Craves and Dr. Carl Goldfischer, are managing directors ofBay City Capital.

 

Underthe securities purchase agreement, we have agreed, if the proposed equityfinancing is completed, to file a registration statement with the SEC covering the resaleof the approximately 92.9 million shares of common stock issued in thefinancing and the approximately 27.9 million shares of common stock issuableupon exercise of the warrants issued in the bridge loan and the equityfinancing.  Upon such registration, theseshares will become generally available for immediate resale in the publicmarket.  The approximately 9.5 millionshares of common stock issued upon conversion of the Series B preferred stocksimilarly will be available for immediate resale pursuant to a registrationstatement or an exemption from registration under Rule 144 of the SecuritiesAct.  The market price of our commonstock could fall as a result of such resales due to the increased number ofshares available for sale in the market.

 

**WHERE YOU CAN FIND MORE INFORMATION**

 

We file annual, quarterly and current reports, as well as registrationand proxy statements and other information, with the Securities and ExchangeCommission.  These documents may be readand copied at the SEC’s public reference rooms in Washington, DC, New York, NYand Chicago IL.  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.  Our reports filed with the SEC after January1, 2003, also are available on our website, www.neorx.com. The informationcontained in our website does not constitute part of, nor is it incorporated byreference into, this report.  We willprovide paper copies of our SEC filings free of charge upon request.

 

***Item 1B.  UNRESOLVED STAFF COMMENTS***

 

Not Applicable.

 

***Item 2.  PROPERTIES***

 

We occupy approximately 21,000 square feet of office space located at300 Elliott Avenue West in Seattle, WA, under a lease that expires July 21,2009.  In February 2003, the administrativeoffices previously located at 410 West Harrison Street, Seattle, WA, wereconsolidated into this location.

 

We continue to occupy approximately 2,900 square feet in a building anda parking area adjacent to the 410 West Harrison Street building.  In 2003, we made improvements and converted2,500 square feet of the space into a laboratory used for research anddevelopment activities.  The balance ofthe space is used for storage.  The leaseon this building expires on May 31, 2006.

 

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In May 2004, we entered into a sublease for executive office spaceat 750 Battery St., San Francisco, CA. We currently occupy two offices at that location.  The lease is month-to-month and is terminableupon 30 days notice.

 

We believe that the foregoing facilities are in good condition and areadequate for all present uses.

 

In April 2001 we acquired a radiopharmaceutical manufacturingfacility located on 12 acres in Denton, Texas. The main building isapproximately 88,000 square feet and houses approximately 12,000 square feet ofclean rooms.  From 2001 to 2005, we usedthe facility to manufacture our skeletal targeted radiotherapy (STR) compound.In May 2005, we announced the immediate implementation of a strategicrestructuring program to refocus our limited resourced on the development ofpicoplatin.  The restructuring plan,which was completed in June 2005, included cessation of manufacturingoperations at our Denton, Texas facility. We are actively working to sell the facility.  Any sale of the Denton facility is subject toapproval of Texas State Bank, McAllen, Texas, which holds a first lien on theproperty, the facility and related assets.

 

***Item 3.  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. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSAND ISSUER PURCHASES OF EQUITY SECURITIES***

*** ***

Our common stock is listedon the The Nasdaq Capital Market (formerly the Nasdaq SmallCap Market). Thefollowing table sets forth, for the periods indicated, the high and low salesprices for our common stock as reported on The Nasdaq Capital Market.  These quotations reflect inter-dealer priceswithout retail mark-up, markdown or commission, and may not necessarilyrepresent actual transactions.

 
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2005**       |       |     |       |    |       |
| First Quarter  |       | $        | 2.34       |    | $          | 0.99 |   |
| Second Quarter |       | 0.97     |       | 0.47    |       |
| Third Quarter  |       | 1.12     |       | 0.62    |       |
| Fourth Quarter |       | 1.26     |       | 0.75    |       |
| **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    |       |

 

The closing price of ourcommon stock on The Nasdaq Capital Market was $1.46 on February 17, 2006.

 

There were approximately 902shareholders of record as of February 17, 2006.  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 paid any cashdividends on our common stock since our inception and do not intend to pay cashdividends on our common stock in the foreseeable future.

 

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***Item6.  SELECTED FINANCIAL DATA (IN THOUSANDS,EXCEPT PER SHARE DATA)***

 

The following table showsselected financial data.  It is importantto read this selected financial data along with the “Financial Statements andSupplementary Data,” as well as “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

 
| ** **                                                      | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                      | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                | ** ** |
| **Consolidated Statement of Operations Data:**                  |       |                              |       |   |   |   |   |   |   |   |   |
| Revenues                                                        |       | $                                 | 15         |   | $ | 1,015 |   | $ | 10,531 |   | $ | 11,054 |   | $ | 2,873 |   |
| Operating expenses                                              |       | 21,075                            |       | 20,502 |   | 15,218 |   | 34,949 |   | 29,020 |   |
| Loss from operations                                            |       | (21,060                           | )          | (19,487 | ) | (4,687 | ) | (23,895 | ) | (26,147 | ) |
| Net loss                                                        |       | (20,997                           | )          | (19,371 | ) | (5,059 | ) | (23,093 | ) | (23,802 | ) |
| Net loss applicable to common shareholders                      |       | (21,497                           | )          | (19,871 | ) | (7,535 | ) | (23,593 | ) | (24,303 | ) |
| Net loss per common share – basic and  diluted             |       | $                                 | (0.64      | ) | $ | (0.66 | ) | $ | (0.28 | ) | $ | (0.89 | ) | $ | (0.92 | ) |
| Weighted average common shares outstanding -  basic and diluted |       | 33,665                            |       | 30,143 |   | 27,280 |   | 26,645 |   | 26,402 |   |
| **Consolidated Balance Sheet Data:**                            |       |                              |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and restricted cash                      |       | $                                 | 4,523      |   | $ | 16,254 |   | $ | 15,166 |   | $ | 6,564 |   | $ | 4,097 |   |
| Investment securities                                           |       | —                            |       | 1,499 |   | 12,335 |   | 9,572 |   | 29,484 |   |
| Working capital (deficit)                                       |       | (1,880                            | )          | 15,689 |   | 26,064 |   | 14,195 |   | 31,123 |   |
| Total assets                                                    |       | 10,114                            |       | 27,436 |   | 35,691 |   | 25,993 |   | 51,028 |   |
| Note payable, net of current portion                            |       | —                            |       | 3,905 |   | 4,112 |   | 5,182 |   | 5,696 |   |
| Shareholders’ equity                                       |       | $                                 | 3,173      |   | $ | 20,828 |   | $ | 29,490 |   | $ | 17,576 |   | $ | 41,715 |   |

 

***Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS***

*** ***

#### **Introduction**

#### ** **

The following discussionof results of operations, liquidity and capital resources containsforward-looking statements that involve risks and uncertainties.  As described under the heading “ImportantInformation Regarding Forward-Looking Statements” at the beginning of thisreport, our actual results may differ materially from the results discussed inthe forward-looking statements.  Factorsthat might cause or contribute to such differences include those discussedbelow and in the section above entitled “Risk Factors.”

 

#### **Critical Accounting 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) andEmerging Issues Task Force Consensus No. 00-21, revenues fromcollaborative agreements are recognized as earned as we perform researchactivities under the terms of each agreement. Billings in excess of amounts earned are classified as deferredrevenue.  To the extent that atransaction contains multiple deliverables, we determine whether the multipledeliverables are separable, and, if separable, the revenue to be allocated toeach deliverable based on fair value.  Iffair value is undeterminable for undelivered elements of the arrangement, revenueis deferred over 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, 2005, we had approximately $0.3 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 

 

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decrease in market value, a significant change in asset condition or asignificant adverse change in regulatory climate.  Application of the test for impairmentrequires judgment.

 

InJune 2005, we recognized an asset impairment loss of $3.3 million oncertain facilities and equipment resulting from our decision to terminate ourSTR program. The loss on the Denton manufacturing facility and relatedequipment was determined based primarily on an appraisal study commissioned byus.  We used a fair value of $3.3 millionfor the Denton facility in determining the impairment loss.  This valuation was the result of weightingthe range of values in the appraisal study, which varied from $3.1 million to$5.1 million. The loss on the equipment at the Seattle facility was determinedbased on estimates of potential sales values of used equipment.  Due to the inherent uncertainty of the timingof a sale of the Denton facility, we classified this asset as a long term assetheld for sale.

 

*Long Term Debt:*  We assumed our note payable to Texas StateBank in connection with the acquisition of our radiopharmaceuticalmanufacturing facility in Denton, Texas. The assets acquired secure the note payable.  At December 31, 2005, the note payable wasfurther secured by a $1.0 million certificate of deposit pledged to Texas StateBank, which was applied to the outstanding balance of the note onJanuary 31, 2006.  We entered into aletter agreement dated January 30, 2006 with Texas State Bank that changedthe maturity date of our promissory note with the Bank to June 5,2006.  Accordingly we have classified theBank note’s entire outstanding balance of approximately $3.9 million at December 31,2005 as current.  The outstanding balanceof the Bank note at February 17, 2006 was approximately $2.8 million.

 

*Stock Compensation:*  We currently measurecompensation cost using the intrinsic value-based method of accounting forstock options granted to employees and disclose the impact of the fair valuemethod in the footnotes to the consolidated financial statements. In December 2004,the Financial Accounting Standards Board issued a revised Statement ofFinancial Accounting Standards No. 123, “Share Based Payment,” whichrequires that fair value be recorded in the results of operations beginning nolater than July 1, 2005. Since there is no market for trading employee stock options, there is no certaintythat the result of the fair value method would be the value at which employeestock options would be traded for cash. Fair value methods require severalassumptions, the most significant of which are stock price volatility and theaverage life of an option. See “New Accounting Pronouncements” below foradditional information.

 

#### **Results of Operations**

#### ** **

***Year Ended December 31, 2005 Compared with December 31, 2004***

 

Our revenues for 2005totaled $15,000, which primarily consisted of royalty payments.  Our revenues for 2004 totaled $1.0 million,which consisted primarily of milestone payments from Boston ScientificCorporation.

 

Total operating expensesincreased 3% to $21.1 million for the year ended December 31, 2005, from$20.5 million for the same period in 2004.

 

Research and developmentexpenses for the year ended December 31, 2005 decreased 24% to $10.2million, from $13.3 million for the same period in 2004.  Among the primary components of the decreasewere a $7.3 million decrease in costs related to the STR program, offset by a$3.6 million increase in picoplatin program development costs, a $0.3 millionreduction in shared-cost reimbursements and a $0.3 million increase indevelopment related overhead costs.

 

General and administrativeexpenses decreased 17% to $5.9 million for the year ended December 31,2005, from $7.2 million for the same period in 2004.  The decrease in G&A costs was dueprimarily to a decrease of $1.0 million for personnel related costs.

 

In March 2005, weraised approximately $3.8 million in net proceeds from the sale in a privateplacement of 3,320,000 shares of common stock. In connection with this private placement, we issued five-year warrantsto purchase an aggregate of 1,328,000 shares of common stock at an exerciseprice of $2.00 per share.  The warrantsbecame exercisable beginning on September 3, 2005 and, thereafter, areexercisable at any time during their term.

 

Until May 2005, our major research and development program hadbeen skeletal targeted radiotherapy (STR), a bone-targetingradiotherapeutic.  In May 2005, weannounced the immediate 

 

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implementation of a strategic restructuring program to refocus ourlimited resources on the development of picoplatin.  The restructuring plan, which was completedin June 2005, included the discontinuation of our STR development program,including halting patient enrollment in our Phase III trial of STR in multiplemyeloma, ceasing operations at our Denton, Texas facility, where STR wasmanufactured, and reducing our workforce by approximately 50%.  We recorded restructuring charges against operationstotaling $1.7 million during 2005.  Thischarge consisted of severance costs totaling $0.9 million associated with thereduction in workforce and contract termination and decommissioning costs of$0.8 million.

 

We evaluated our STR assets in light of the restructuring anddetermined that a likely impairment existed on those assets.  We recorded a charge of $3.3 million againstoperations in June 2005 to reflect such impairment.  The asset impairment charge reflects the difference in theestimated fair value of assets as compared to the net book value of assetsemployed in our STR program.

 

In conjunction with our strategic restructuring, in June 2005 wenegotiated the early termination of our STR-related supply agreement with theUniversity of Missouri Research Reactor facility group (MURR).  We paid MURR a fee of $368,000 in connectionwith such early termination***.*** During2005 we paid $190,000 in minimum purchase requirements under the agreement.

 

Other income totaled $0.1million in 2005 and 2004, respectively. These amounts consisted of interest income of $0.3 million, offset byinterest expense of $0.2 million.

 

Preferred dividends on Series 1Preferred Stock were $0.5 million in both 2005 and 2004.

 

***Year Ended December 31, 2004 Comparedwith December 31, 2003***

 

Our revenues for 2004 totaled$1.0 million, which primarily consisted of milestone payments from BostonScientific Corporation.  Our revenues for2003 totaled $10.5 million, which primarily consisted of $10.0 million from theassignment and licensing to Boston Scientific Corporation of certainintellectual property and revenue from a facilities lease.

 

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

 

Research and developmentexpenses for the year ended December 31, 2004 increased 39% to $13.3million, from $9.6 million for the same period in 2003.  Among the primary components of the increasewere a $4.0 million in increased costs related to the STR Phase III trial,which was opened in March 2004, and a $0.6 million increase inpre-clinical development costs related to picoplatin, offset by a $0.2 milliondecrease resulting from the curtailment of our Pretarget program in July 2002.

 

General and administrativeexpenses increased 14% to $7.2 million for the year ended December 31,2004, from $6.3 million for the same period in 2003.  The increase in G&A costs for the yearended 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, weraised approximately $9.0 million in gross proceeds through the sale in aprivate 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 generaland administrative expense of $118,000 for the fair value of the warrants on February 23, 2004.

 

InApril 2004, we acquired from AnorMED, Inc. the worldwide exclusiverights, excluding Japan, to develop, manufacture and commercialize picoplatin (NX473), a platinum-based anti-cancer agent. Under the terms of the agreement, we paid AnorMED a one-time upfrontmilestone payment of $1.0 million in our common stock and $1.0 million in cash.

 

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

 

InMarch 2004, we entered into a contract with the University of MissouriResearch Reactor facility group (MURR), under which MURR was responsible forthe manufacture, including process 

 

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qualification,quality control, packaging and shipping of the holmium-166 component of STR for our STRPhase III trial.  In November 2004,we exercised our option to extend the term of the agreement until March 1,2006.  Under the contract, we paid afixed price per unit of holmium-166 ordered, subject to a minimum purchaserequirement, and fixed amounts for handling and maintenance.  During 2004 we purchased the minimumquantities under the contract, which totaled approximately $510,000.

 

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

 

***Major Research and Development Projects***

 

Our major researchand development project during the fiscal years ended December 31, 2005,2004 and 2003 was skeletal targeted radiotherapy (STRTM), a bone-targetingradiotherapeutic.  In May 2005, we implementeda strategic restructuring to refocus our resources on the development ofpicoplatin (NX 473), a next generation platinum-based therapy. Thisrestructuring included the discontinuation of our STR development program,including halting further patient enrollment in our Phase III trial of STR inmultiple myeloma, ceasing operations at our Denton facility, where STR wasmanufactured and reducing our workforce by approximately 50%.

 

*SkeletalTargeted Radiotherapy***.**  STR is a radiotherapeutic designed to deliverradiation specifically 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 $58.2 millionin connection with the STR program since the program’s inception in 1998.

 

Total estimated costs to complete the STR clinicaltrial and potentially obtain marketing approval were in the range of $35-40million, including cost of clinical drug supply.  These costs would have been substantiallyhigher if we were required to repeat, revise or expand the scope of our trialsor conduct additional clinical trials. The termination of the STR development program relieved us of the annualcosts associated with the program, including the manufacturing, clinical trialand personnel costs.  During 2004, thesecosts were approximately $10.2 million. For 2005 these costs were expected to be approximately $4.5million.  Actual costs incurred inconnection with the STR program in 2005 were $2.9 million.  We are actively seeking a buyer for theDenton facility and our STR related assets. Given the inherent uncertainty of the timing of a sale of the Dentonfacility, we have classified this asset as long-term.

 

STR was a clinical stage product for which nomarketing approvals have been obtained. We had no material cash inflows relating to our STR development and didnot receive any revenues from product sales of STR.  Due to our decision to curtail our STRdevelopment program, there is neither an anticipated completion date nor anexpected period during which material cash inflows will commence.  As a consequence of the restructuring, we arenot dependent on the successful development and completion of our STR program and,therefore, there are no risks and uncertainties associated with the STR programthat will materially impact our operations or financial position.

 

*Picoplatin***. **Ourcurrent major research and development project is picoplatin (NX 473), anext-generation platinum-based cancer therapy designed to overcome platinumresistance in the treatment of solid tumors. We initiated a Phase II clinical study of picoplatin in small cell lungcancer in June 2005 and enrolled the first patient in July 2005.  As of December 31, 2005, we haveincurred costs of approximately $4.7 million in connection with the picoplatinclinical program.  Total estimated coststo complete the picoplatin Phase II trial in small cell lung cancer are in therange of $10 to $12 million for the period through 2007, including the cost ofdrug supply.  The costs could besubstantially higher if we have to repeat, revise or expand the scope of ourtrial.  Material cash inflows relating toour picoplatin development will not commence unless and until we completerequired clinical trials and obtain FDA marketing approvals, and then only ifpicoplatin finds acceptance in the marketplace. To date, we have not received any revenues from product sales ofpicoplatin.

 

The risks and uncertainties associated with completingthe development of picoplatin on schedule or at all, include thefollowing, as well as the other risk factors described in this report:

 

•                  we may not have adequate funds to complete the development ofpicoplatin;

 

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•                  we may be unable to secure adequate supplies of picoplatin drug productin order to complete our clinical trials;

 

•                  picoplatin may not be shown to be safe and efficacious in clinicaltrials; and

 

•                  we may be unable to obtain regulatory approval of the drug or may beunable to obtain such approval on a timely basis.

 

If we fail to obtain marketing approval forpicoplatin, are unable to secure adequate clinical and commercial supplies ofpicoplatin drug product, or do not complete development and obtain regulatoryapproval on a timely basis, our operations, financial position and liquiditycould be severely impaired, including as follows:

 

•      wewould not earn any sales revenue from picoplatin, which would increase thelikelihood that we would need to obtain additional financing for our otherdevelopment efforts; and

 

•      ourreputation among investors might be harmed, which could make it more difficultfor us to obtain equity capital on attractive terms or at all.

 

Because of the many risks and uncertainties relatingto completion of clinical trials, receipt of market approvals and acceptance inthe marketplace, we cannot predict the period in which material cash inflowsfrom our picoplatin program will commence, if ever.

 

*Summary of Research andDevelopment Costs***.**  Our development administration overheadcosts, consisting of rent, utilities, consulting fees, patent costs and othervarious overhead costs, are included in total research and development expensefor each period, but are not allocated among our various projects.  Finally, our total development costs includethe costs of various other research efforts directed toward the identificationand evaluation of future product candidates. These other research projects are pre-clinical and not considered majorprojects.  Our total research anddevelopment costs are summarized below**:**

 
| **Summary of Research and Development Costs** | ** ** |
|-----------------------------------------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                          |       | **(in thousands)** |   |
|                                          |       |   |   |   |   |   |   |
| STR                                           |       | $ | 2,864 |   | $ | 10,155 |   | $ | 6,169 |   |
| Picoplatin                                    |       | 4,150 |   | 555 |   | — |   |
| Other overhead and research costs             |       | 3,184 |   | 2,621 |   | 3,422 |   |
| Total research and development costs          |       | $ | 10,198 |   | $ | 13,331 |   | $ | 9,591 |   |

 

###### ***Proposed Equity Financing***

###### *** ***

OnFebruary 1, 2006, we entered into a securities purchase agreement with institutionaland other accredited investors for a $65 million private placement of newlyissued shares of our common stock and the concurrent issuance of warrants forthe purchase of additional shares of common stock.  We also completed a bridge loan for approximately$3.46 million to be used as working capital to fund operations until theanticipated completion of the equity financing. The closing of the equity financing, including the issuance of thesecurities and the receipt of proceeds, is subject to shareholder approval inaccordance with Nasdaq Marketplace Rules, as well as to satisfaction ofcustomary and other conditions of closing, including shareholder approval of anamendment to our articles of incorporation to increase our authorized common stockto provide for a sufficient number of common shares to complete the financing.

 

Assumingreceipt of required shareholder approvals and satisfaction of other closingrequirements, we would issue to the investors an aggregate of approximately92.9 million shares of

 

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commonstock at a purchase price of $0.70 per share, together with five-year warrantsto purchase an aggregate of approximately 25.4 million shares of common stockat an exercise price of $0.77 per share. The securities purchase agreement may be terminated at any time bymutual written agreement by us and the holders of at least 60% in interest ofthe notes held by the investors pursuant to the bridge loan.  The securities purchase agreement may beterminated by either us or the holders of at least 60% in interest of thebridge notes (i) in the event of a material breach by the other party, (ii) ifany governmental entity issues an injunction or other ruling prohibiting theproposed equity financing, or (iii) if the proposed equity financing doesnot close on or before May 31, 2006. During the term of the securities purchase agreement, we have agreed,subject to customary fiduciary exceptions, not solicit or participate innegotiations with any third parties relating to the sale of 10% or more of ourbusiness, assets or capital shares. Moreover, if we receive any third party offer to provide financing or toenter into a transaction below the 10% threshold, we must first endeavor tonegotiate with the investors for a period of up to 15 business days and, if theinvestors offer to provide such financing or enter into such transaction onterms no less favorable than those offered by third parties, we must accept theinvestors’ offer if we accept any offer.

 

Inconnection with the proposed equity financing, on February 1, 2006, theholders of all of our outstanding shares of Series B convertible preferredstock executed an agreement, subject to the closing of the proposed equityfinancing, to convert their shares of Series B preferred stock into sharesof common stock, at an adjusted conversion rate of 6060.6061 shares of commonstock for each Series B share.  Subjectto shareholder approval of the proposed financing and the proposed amendment ofour articles of incorporation, we would, concurrently with the closing of theequity financing, issue to holders of the Series B preferred stock anaggregate of approximately 9.5 million shares of common stock in suchconversion.  The agreement to convert expireson the earliest to occur of (i) any event pursuant to which all of theoutstanding shares of Series B preferred stock are converted into sharesof common stock; (ii) the consummation of a liquidation (as that term isdefined in Section 3(d) of the Series B Designation); and (iii) June 1,2006.

 

Aspecial meeting of shareholders has been scheduled for April 11, 2006 toseek the shareholder approvals required to complete the proposed equityfinancing.  Detailed information aboutthe proposals to be presented at the special meeting will be contained in theproxy statement filed with the SEC and mailed to shareholders prior to themeeting.  The Company, our board ofdirectors, executive officers and employees, and certain other persons may bedeemed to be participants in the solicitation of proxies of Companyshareholders to approve the issuance of securities and the amendment of thearticles of incorporation in connection with the proposed financing.  These individuals may have interests in thetransaction, including interests resulting from their participation as aninvestor in the transaction or their ownership of common stock or options orother securities of the Company. Information concerning these individuals and their interests in thetransaction and their participation in the solicitation will be contained inthe proxy statement to be filed with the SEC. *Shareholders of the Company are advised to read theproxy statement and any other relevant documents filed with the SEC when theybecome available because they will contain important information.*

 

***Liquidity and Capital Resources***

 

Wehave historically suffered recurring operating losses and negative cash flowsfrom operations.  As of December 31,2005, we had net negative working capital of $1.9 million and had anaccumulated deficit of $255.8 million with total shareholders’ equity of $3.2million.  In May 2005, weimplemented a strategic restructuring plan to reduce costs by discontinuing ourSTR development program and other STR related activities.  We have no assurance that our restructuring orany other cost savings alternatives will be successful.  We may not be able to obtain the requiredadditional capital or enter into relationships with corporate partners on atimely basis, on favorable terms, or at all. The report of our independent registered public accountants issued inconnection with our annual report on Form 10-K for the year ended December 31,2005 contains a statement expressing substantial doubt regarding our ability tocontinue as a going concern. Conditions in the capital markets in general, andthe life science capital market specifically, may affect our potentialfinancing sources and opportunities for strategic partnering.  If we are unable to close the proposed equityfinancing described above or otherwise obtain sufficient cash to fund ouroperations, we may be forced to explore liquidation alternatives, includingseeking protection from creditors under the bankruptcy laws.

 

Wehave financed our operations primarily through the sale of equity securities,technology licensing, 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, net of restricted cash of $1.0 million, totaled $3.5 million at December 31, 2005compared to 

 

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$17.8million at December 31, 2004.  Weprimarily fund currentoperations with our existing cash and investments.  Cash used for operating activities for thetwelve months ended December 31, 2005 totaled $16.5 million.** **This included $1.3million in costs incurred as part of the STR restructuring.  Revenues and other income sources for 2005were not sufficient to cover operating expenses.

 

We raisedapproximately $3.8******million in net proceeds fromthe sale of common stock and warrants in a private placement transaction in March 2005.  We have applied the net proceeds from thisfinancing to support our Phase II trial in picoplatin in small cell lung cancerand for general working capital, including restructuring costs associated withthe termination of our STR development program. We raised approximately $9.0million in net proceeds from the sale of common stock and warrants in a privateplacement transaction in February 2004. The net proceeds from this financing was used to support STR developmentprogram, which we discontinued in May 2005, and for general workingcapital.

 

OnFebruary 1, 2006, we received a $3.46 bridge loan from investors in theproposed equity financing described under the heading “Proposed EquityFinancing” above.  Pursuant the bridgeloan, we issued convertible promissory notes for the principal amount of theloan and five-year warrants to purchase an aggregate of approximately 2.5million shares of common stock at an exercise price of $0.77 per share.  The proceeds of the bridge loan will be usedfor working capital pending receipt of anticipated shareholder approvals inconnection with the proposed equity financing. The bridge notes have an interest rate of 8% per annum and, at theclosing of the proposed equity financing, if such occurs, automatically wouldconvert into an aggregate of approximately 5.0 million shares of commonstock.  The notes are secured by a firstlien on certain of our assets pursuant to a security agreement between us andthe investors dated as of February 1, 2006.  The bridge notes will mature on the earliestof (i) May 31, 2006, (ii) the closing of the proposed equityfinancing, and (iii) the written election of the holders of 60% ininterest of the principal amount of the bridge notes following an event ofdefault under the terms of the bridge notes. If the proposed equity financing is not completed on or before May 31,2006, or there occurs an event of default under the bridge notes, or the ifbridge notes are outstanding after May 31, 2006, the principal amount ofthe bridge notes and all accrued and unpaid interest may, subject to certainlimitations, be converted at the option of the holders into shares of commonstock at the lesser of (i) $0.70 per share or (ii) the greater of:(X) $0.45 per share or (Y) the closing per share bid price on the date of theevent of default or May 31, 2006, as applicable.  Unless previously converted, the outstandingprincipal balance and all accrued and unpaid interest under the bridge noteswill, after the maturity date, bear interest at an increased rate of 13% fromand after the date of default to the date of payment in full of the unpaid amount.

 

Asa condition to closing of the bridge loan, we executed a letter agreement datedJanuary 30, 2006 with Texas State Bank, pursuant to which we agreed tochange the maturity date of our promissory note with the Bank to June 5,2006.  We originally entered into a theBank note in connection with our 2001 purchase of a radiopharmaceuticalmanufacturing plant and other assets located in Denton, Texas.  As part of that transaction, we assumed $6.0million principal amount of restructured debt held by Texas State Bank,McAllen, Texas.  The loan is secured bythe assets acquired in the transaction. The interest rate on the loan was 7.25% on December 31, 2005.  The interest rate, which is equal to the bankprime rate and is adjusted on the same date that the bank prime rate changes asreported in the Wall Street Journal, was 7.50% on February 17, 2006.  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 the years ended December 31,2005 and 2004 totaled $601,000 and $486,000, respectively. With theimplementation of the restructuring plan in May 2005 (see Note 8), webegan selling excess equipment previously used in the manufacturing facility.  Under the terms of the note, the proceeds fromthe sale of such equipment in 2005 ($115,000) were applied against theprincipal balance of the note.  The fixedmonthly payments on the note are recalculated in April of each year basedon the then current bank prime interest rate and outstanding note balance.  Based on an interest rate of 7.50% (effectiveJanuary 31, 2006) and taking into account the early payment of $1.0million in principal under the arrangement described below, the estimatedprincipal balance payable at maturity would be $2.7 million.

 

Theterms of the Texas State Bank loan provide that an event of default may bedeemed to occur if we abandon, vacate or discontinue operations on asubstantial portion of the Denton facility or there is a material adversechange in our financial condition, results of operations, business orproperties. If this were to occur, Texas State Bank could declare the entireamount of the loan ($2.8 million at February 17, 2006) due and immediatelypayable.  In such case, our cashresources and assets could be impaired depending on our ability to raise fundsthrough a sale of the Denton facility or other means.  As a result of the restructuring and thedecision to discontinue its STR development program, we have ceasedmanufacturing operations at the Denton facility and are actively working tosell the facility and other STR assets. We have listed the Denton facility forsale at a price of $3.3 million.  Anysales of the Denton 

 

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facilityor other Denton assets are subject to approval of the Bank. As of December 31, 2005, we received aggregate proceeds of $115,000from the sale of equipment and other assets. These proceeds were applied to the outstanding principal balance of theloan.  There can be no assurance that theBank will approve the price or other terms of any offer received by us to buythe Denton facility or other STR assets, or that the sale proceeds, if any,received by us from such sales will be sufficient to satisfy the outstandingbalance of the Bank loan.

 

InOctober 2005, we placed $1.0 million in cash in a restricted depositaccount with the Bank as additional collateral to secure the payment of theloan.  We further agreed that if we wereunable to obtain at least $15.0 million in new financing on or before January 31,2006, the Bank may apply the $1.0 million cash deposit to the payment of thelast maturing installments on the loan. In return, the Bank agreed that our cessation of operations at the Dentonfacility will not be declared an event of default under the loan as long as wecontinue to pay insurance and taxes on and otherwise maintain thefacility.  Additionally, the Bank agreed,prior to January 31, 2006, not to declare the loan in default on the basisthat there has been a material adverse change in our financial condition,results of operations, business or properties. Pursuant to this agreement, theBank, as of January 31, 2005, applied the $1.0 million cash collateral andall interest accrued thereon to the outstanding balance of the Bank note.  By letter agreement dated January 30,2006, the Bank agreed, in exchange for our agreement to accelerate the maturitydate of the note, to continue the forbearance under the October 2005agreement until June 5, 2006.  Webelieve that this will allow us time to seek required shareholder approvals andto close the proposed equity financing; however, we have no assurance that suchapproval will be received or that the proposed financing will be completed in atimely manner, if at all.

 

OnAugust 4, 2005, we entered into a Research Funding and Option Agreementwith The Scripps Research Institute, or TSRI. Under the agreement, we have agreed to provide TSRI an aggregate of $2.5million over a 26-month period to fund research relating to synthesis andevaluation of novel small molecule, multi-targeted protein kinase inhibitors astherapeutic agents, including for the treatment of cancer.  We have the option to negotiate a worldwideexclusive license to use, enhance and develop any compounds arising from thecollaboration.  The research funding ispayable by us to TSRI quarterly in accordance with a negotiated budget.  We made an initial funding payment to TSRI of$137,500 on August 8, 2005, and we are obligated to make additionalaggregate funding payments of $1.0 million and $1.4 million in 2006 and 2007,respectively.

 

Withthe proceeds from the bridge loan, we had total cash and marketable securitiesof $4.7 million at February 17, 2006. We believe that our current cash and cash equivalent balances, includingthe proceeds of the bridge loan, will provide adequate resources to fundoperations at least until May 31, 2006. If we do not receive required shareholder approvals in connection withthe proposed equity financing and complete the proposed equity financing in atimely manner, we will not have funds to pay off the bridge notes and the Banknote when they become due and payable or to fund our continuingoperations.  In such case, there is asubstantial likelihood that we will be forced to explore liquidationalternatives, including seeking protection from creditors under the bankruptcylaws.

 

Weacquired the worldwide exclusive rights, excluding Japan, to develop,manufacture and commercialize picoplatin from AnorMED, Inc. in April 2004.  Under the terms of the agreement, we paidAnorMED a one-time upfront milestone payment of $1.0 million in common stockand $1.0 million in cash.  The agreementalso provides for additional milestone payments to AnorMED of up to $13million, payable in cash or a combination of cash and common stock.  Upon regulatory approval, AnorMED wouldreceive royalty payments of up to 15% on product sales.  We initiated our first picoplatin clinicaltrial, a Phase II study of picoplatin in small cell lung cancer, in July 2005,and it is unlikely that these milestones would be triggered during 2006.  Because we cannot predict the length of timeto completion of our Phase II study, the time of initiation and completion of aPhase III study or the time of submission of a New Drug Application forpicoplatin, we are unable to predict when such milestones might be triggeredafter 2006.

 

Alsoin April 2004, we sold and transferred our Pretarget intellectual propertyto Aletheon Pharmaceuticals, Inc. Under the agreement, we could receive up to $6.6 million in milestonepayments if Aletheon achieves certain development goals, plus royalties onpotential future product sales.  We didnot receive any upfront consideration for the sale of the Pretargetproperty.  We discontinued our clinicalstudies using the Pretarget technology in July 2002, and sought, boththrough targeted inquiries and a broad-based auction process, a buyer orlicensee for the technology.  The sale ofthe Pretarget intellectual property relieved us of the annual costs associatedwith maintaining the Pretarget patent estate. During 2003, we spent approximately $350,000 for the prosecution andmaintenance of the 

 

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Pretarget patents and trademarks. For 2004, these costs were approximately $70,000.  Seattle-based Aletheon is a development stagebiotherapeutics company founded by two former NeoRx employees.  The timing and amount of milestone payments,if any, are uncertain.  The terms of thetransaction were determined through arms-length negotiation.

 

InApril 2003, we received $10 million from the sale to Boston ScientificCorporation, or BSC, of certain non-core patents and patent applications andthe grant to BSC of exclusive license rights to certain patents and patentapplications.  BSC originally assertedfour such patents in two lawsuits against Johnson & Johnson, Inc.,its subsidiary, Cordis Corporation, and Guidant Corporation, alleginginfringement of such patents.** **In both lawsuits, the defendantsdenied infringement and asserted invalidity and unenforceability of thepatents.  BSC subsequently withdrew threeof the patents from the litigation, including the patents that were assigned toBSC. We understand that BSC is still asserting a licensed patent against thedefendants, but has also agreed, in principle, to purchase Guidant.  Although we are not currently a party to thelawsuits, our management and counsel have been deposed in connection with thelawsuits.  It is possible that BSC, if itis unsuccessful or has limited success with its claims, may seek damages fromus, including recovery of all or a portion of the amounts it paid to us in2003.  We cannot assess the likelihood ofwhether such claim will be brought against us or the extent of recovery, ifany, on any such claim.

 

Althoughthere can be no assurance, if we complete the proposed $65 million equityfinancing, we will require substantial additional funding to develop andcommercialize picoplatin and any other proposed products and to fund ouroperations.

 

Managementis continuously exploring alternatives, including:

 

•      raisingadditional capital through the public or private sale of equity or debtsecurities or through the establishment of credit or other funding facilities;and

 

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

 

Ouractual capital requirements will depend upon numerous factors, including:

 

•      the scopeand timing of our picoplatin clinical program and other research anddevelopment efforts, including the progress and costs of our Phase II trial ofpicoplatin in small cell lung cancer;

 

•      ourability to obtain clinical supplies of picoplatin drug product in a timely andcost effective manner;

 

•      actionstaken by the FDA and other regulatory authorities;

 

•       thetiming and amounts of proceeds from any sale of the Denton facility and assets;

 

•      ouralternatives with respect to the STR assets, including any potentialdisposition or out-licensing alternatives and the timing, type and amount ofconsideration received and other terms of any such transactions;

 

•      thetiming and amount of any milestone or other payments we might receive from orpay to potential strategic partners;

 

•      ourdegree of success in commercializing picoplatin or any other cancer therapyproduct candidates;

 

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

 

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

 

•      the costsof any research collaborations or strategic partnerships established, if we 

 

35

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            choosesto pursue such activities and

 

•      the costsof preparing, filing, prosecuting, maintaining and enforcing patent claims andother intellectual property rights.

 

We have netoperating loss carryforwards of approximately $138 million, which expire from2006 through 2025.  If the proposedequity financing is completed, a change of control would occur that may limitour ability to utilize these net operating loss carryforwards.  If such limitation occurs, we may incurhigher tax expense, which also would affect our capital requirements.

 

Our financial statements areprepared on a going concern basis; however, our inability to obtain additional capitalas needed could have a material adverse effect on our financial position,results of operations and our ability to continue in existence. Ourconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

At December 31,2005, we had the following long-term commitment (in thousands):

 
| ** **                     | ** ** | **Less than   1 year** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------------------|------------|---------------|------------|---------------|------------|----------------|------------|-----------|------------|
| Lease commitments              |       | $                      | 630        |          | $          | 1,138         |       | $              | 326        |      | $          | — |   | $ | 2,094 |   |
| Purchase commitments - Scripps |       | 1,013                  |       | 1,350         |       | —        |       | —         |       | 2,363     |       |
| Total commitments              |       | $                      | 1,643      |          | $          | 2,488         |       | $              | 326        |      | $          | — |   | $ | 4,457 |   |

 

**NewAccounting Pronouncements**

 

In May 2005, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and ErrorCorrections, a Replacement of APB Opinion No. 20 and FASB Statement No. 3.”  SFAS 154 establishes, unlessimpracticable, retrospective application as the required method for reporting achange in accounting principle in the absence of explicit transitionrequirements specific to a newly adopted accounting principle. Previously, mostchanges in accounting principle were recognized by including the cumulativeeffect of changing to the new accounting principle in net income of the periodof the change. Under SFAS 154, retrospective application requires (i) thecumulative effect of the change to the new accounting principle on periodsprior to those presented to be reflected in the carrying amounts of assets andliabilities as of the beginning of the first period presented, (ii) anoffsetting adjustment, if any, to be made to the opening balance of retainedearnings (or other appropriate components of equity) for that period, and (iii) financialstatements for each individual prior period presented to be adjusted to reflectthe direct period-specific effects of applying the new accounting principle.Special retroactive application rules apply in situations where it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. Indirect effects of a change in accounting principle arerequired to be reported in the period in which the accounting change ismade.  SFAS 154 carries forward theguidance in APB Opinion 20 “Accounting Changes,” requiring justification of achange in accounting principle on the basis of preferability.  SFAS 154 also carries forward withoutchange the guidance contained in APB Opinion 20, for reporting thecorrection of an error in previously issued financial statements and for achange in an accounting estimate. SFAS 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. The Company does not expect SFAS 154 will significantly impact itsfinancial statements upon its adoption on January 1, 2006.

 

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-BasedCompensation,” issued in 1995. SFAS 123R requires that the fair value of thegrant of employee stock options be reported as an expense in the results of operations.  SFAS 123Reliminates the ability to account for stock-based compensation usingAPB 25 and requires that such transactions be recognized as compensationcost in the income statement based on their fair values on the measurement date,which is generally the date of the grant. The Statement is effective for the first annual reporting periodthat begins after June 15, 2005. Historically, the Company has disclosed in its footnotes the pro formaexpense effect of the grants.   Stock compensation expense underthe prior rules would have increased reported diluted loss per share by$.03 in 2005.  SFAS 123R willapply to all outstanding, unvested option grants as of the effective date.  The Company plans to adopt SFAS No. 123Reffective beginning in the first quarter of 2006 using the Modified Prospectivemethod.  Under the Modified Prospectivemethod, SFAS 123R applies to new and modified option grants after the effectivedate, and to any unvested option grants as service is rendered on or after theeffective date.  The attribution of compensation cost for vested option grants as of thedate of adoption will be based on the same method and on the same grant-datefair values previously determined for the pro forma disclosures required for 

 

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companiesthat did not adopt the fair value accounting method for stock-based employee compensation. Basedon the stock-based compensation awards outstanding as of December 31, 2005for which the requisite service is not expected to be fully rendered prior to January 1,2006, we expect to recognize total annual compensation cost in 2006 ofapproximately $320,000 to $630,000 resulting from the adoption of SFAS123R.  Future levels of compensation cost recognized related to stock-basedcompensation awards (including the aforementioned expected costs during theperiod of adoption) may be impacted by new awards and/or modifications,repurchases and cancellations of existing awards before and after the adoptionSFAS 123R.

 

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

 

The Company is exposed to the impact of interest rate changes andchanges in the market values of its investments.

 

**Interest Rate Risk**

 

The Company’s exposure to market rate risk for changes in interestrates relates primarily to the Company’s debt securities included in itsinvestment portfolio.  The Company doesnot have any derivative financial instruments. The Company invests in debt instruments of the US Government and itsagencies and high-quality corporate issuers. Investments in both fixed rate and floating rate interest earninginstruments 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 31,2005, the Company did not own any federal government or corporate debtinstruments. 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 promissory note to Texas State Bank bears interest equalto the bank prime rate. The fixed monthly payment amount on the Bank note isrecalculated in April of each year. The maximum permitted interest rate on the note is 18% per annum.Because the interest rate on the note varies with changes in the prime rate,the Company’s interest expenses may increase as the bank prime interest rateincreases.  Extreme increases in the bankprime interest rate, up to the maximum interest rate permitted under the note,could materially affect the Company’s interest expense.  On January 30, 2006, the Company agreedto accelerate the maturity date of the Bank note to June 5, 2006.  The outstanding principal amount of the noteat February 17, 2006 was approximately $2.8 million***.***

 

**Investment Risk**

 

The Company has receivedequity instruments under licensing agreements. These instruments are included in investment securities and areaccounted for at fair value with unrealized gains and losses reported as acomponent of comprehensive loss and classified as accumulated othercomprehensive income — unrealized gain on investment securities in shareholders’equity.  Such investments are subject tosignificant fluctuations in fair market value due to the volatility of thestock market.   At December 31,2005, the Company owned no such corporate equity securities.

 

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 ***Item8.  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA=***

 
| Report of  Independent Registered Public Accounting Firm                                                                                       |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated Balance  Sheets — December 31, 2005 and 2004                                                                            |   |
| Consolidated  Statements of Operations — For the Years Ended December 31, 2005, 2004  and 2003                                       |   |
| Consolidated  Statements of Shareholders’ Equity and Comprehensive Loss — For the Years  Ended December 31, 2005, 2004 and 2003 |   |
| Consolidated  Statements of Cash Flows — For the Years Ended December 31, 2005, 2004  and 2003                                       |   |
| Notes to  Consolidated Financial Statements                                                                                                    |   |

 

All financial schedules are omitted since the required information isnot applicable or has been presented in the financial statements and the notesthereto.

 

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**Report of Independent Registered Public Accounting Firm**

 

The Board of Directors and Shareholders

NeoRx Corporation:

 

We haveaudited the accompanying consolidated balance sheets of NeoRx Corporation andSubsidiary as of December 31, 2005 and 2004, 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 31,2005. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conductedour audits 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 materialmisstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of NeoRx Corporationand Subsidiary as of December 31, 2005 and 2004, and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2004, in conformity with U.S. generally acceptedaccounting principles.

 

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will 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 this uncertainty.

 

KPMG LLP

 

Seattle, Washington

 

February 28, 2006

 

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**NEORX CORPORATION AND SUBSIDIARY**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(in thousands, except share data)

 
| ** **                                                                                                                                                                                                                | ** ** | **December 31** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                                | ** ** | **2005**             | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                                |       |                 |       |   |   |
| **ASSETS**                                                                                                                                                                                                                |       |                 |       |   |   |
| **Current assets:**                                                                                                                                                                                                       |       |                 |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                 |       | $                    | 3,523      |   | $ | 16,254 |   |
| Cash - restricted                                                                                                                                                                                                         |       | 1,000                |       | — |   |
| Investment securities                                                                                                                                                                                                     |       | —               |       | 1,499 |   |
| Prepaid expenses and other current assets                                                                                                                                                                                 |       | 455                  |       | 639 |   |
| Assets held for sale                                                                                                                                                                                                      |       | 83                   |       | — |   |
| Total current assets                                                                                                                                                                                                      |       | 5,061                |       | 18,392 |   |
| **Facilities and equipment:**                                                                                                                                                                                             |       |                 |       |   |   |
| Land                                                                                                                                                                                                                      |       | —               |       | 345 |   |
| Building                                                                                                                                                                                                                  |       | —               |       | 5,779 |   |
| Leasehold improvements                                                                                                                                                                                                    |       | —               |       | 49 |   |
| Equipment and furniture                                                                                                                                                                                                   |       | 829                  |       | 3,122 |   |
|                                                                                                                                                                                                                      |       | 829                  |       | 9,295 |   |
| Less: accumulated depreciation and  amortization                                                                                                                                                                          |       | (556                 | )          | (2,193 | ) |
| Facilities and equipment, net                                                                                                                                                                                             |       | 273                  |       | 7,102 |   |
| Other assets                                                                                                                                                                                                              |       | 45                   |       | 67 |   |
| Assets held for sale                                                                                                                                                                                                      |       | 3,027                |       | — |   |
| Licensed products, net of accumulated  amortization of $292 and $125                                                                                                                                                      |       | 1,708                |       | 1,875 |   |
| **Total assets**                                                                                                                                                                                                          |       | $                    | 10,114     |   | $ | 27,436 |   |
|                                                                                                                                                                                                                      |       |                 |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                            |       |                 |       |   |   |
| **Current liabilities:**                                                                                                                                                                                                  |       |                 |       |   |   |
| Accounts payable                                                                                                                                                                                                          |       | $                    | 995        |   | $ | 1,130 |   |
| Accrued liabilities                                                                                                                                                                                                       |       | 2,078                |       | 1,271 |   |
| Current portion of note payable                                                                                                                                                                                           |       | 3,868                |       | 302 |   |
| Total current liabilities                                                                                                                                                                                                 |       | 6,941                |       | 2,703 |   |
| **Long-term liabilities:**                                                                                                                                                                                                |       |                 |       |   |   |
| Note payable, net of current portion                                                                                                                                                                                      |       | —               |       | 3,905 |   |
| Total long-term liabilities                                                                                                                                                                                               |       | —               |       | 3,905 |   |
|                                                                                                                                                                                                                      |       |                 |       |   |   |
| **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, 2005 and 2004 (entitled in  liquidation to $5,175) |       | 4                    |       | 4 |   |
| Convertible preferred stock, Series B,  1,575 shares issued and outstanding at December 31, 2005 and 2004  (entitled in liquidation to $15,750)                                                                 |       | —               |       | — |   |
| Common stock, $.02 par value, 150,000,000  shares authorized, 34,322,293 and 30,908,753 shares issued and outstanding at  December 31, 2005 and 2004, respectively                                                   |       | 686                  |       | 618 |   |
| Additional paid-in capital                                                                                                                                                                                                |       | 258,283              |       | 254,510 |   |
| Accumulated deficit, including other  comprehensive loss of $0 and $1 at December 31, 2005 and 2004,  respectively                                                                                                   |       | (255,800             | )          | (234,304 | ) |
| Total shareholders’ equity                                                                                                                                                                                           |       | 3,173                |       | 20,828 |   |
| **Total liabilities and shareholders’ equity**                                                                                                                                                                       |       | $                    | 10,114     |   | $ | 27,436 |   |

 
| See accompanying notes to the condensed consolidated financial  statements. |   |
|-----------------------------------------------------------------------------|--------|

 

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**NEORX CORPORATON AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                                                                               | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                               | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                               |       |                              |       |   |   |   |   |
| **Revenues**                                                                                                             |       | $                                 | 15         |   | $ | 1,015 |   | $ | 10,531 |   |
| **Operating expenses:**                                                                                                  |       |                              |       |   |   |   |   |
| Research and development                                                                                                 |       | 10,198                            |       | 13,331 |   | 9,591 |   |
| General and administrative                                                                                               |       | 5,948                             |       | 7,171 |   | 6,265 |   |
| Gain on sale of real estate and equipment                                                                                |       | (158                              | )          | — |   | (638 | ) |
| Asset impairment loss                                                                                                    |       | 3,346                             |       | — |   | — |   |
| Restructuring                                                                                                            |       | 1,741                             |       | — |   | — |   |
| Total operating expenses                                                                                                 |       | 21,075                            |       | 20,502 |   | 15,218 |   |
| Loss from operations                                                                                                     |       | (21,060                           | )          | (19,487 | ) | (4,687 | ) |
| **Other income (expense):**                                                                                              |       |                              |       |   |   |   |   |
| Realized (loss) gain on sale of securities                                                                               |       | —                            |       | — |   | (151 | ) |
| Interest income                                                                                                          |       | 330                               |       | 326 |   | 198 |   |
| Interest expense                                                                                                         |       | (267                              | )          | (210 | ) | (229 | ) |
| Total other income (expense)                                                                                             |       | 63                                |       | 116 |   | (182 | ) |
|                                                                                                                     |       |                              |       |   |   |   |   |
| Net loss before cumulative effect of change  in accounting principle                                                     |       | (20,997                           | )          | (19,371 | ) | (4,869 | ) |
|                                                                                                                     |       |                              |       |   |   |   |   |
| Cumulative effect of change in accounting  principle                                                                     |       | —                            |       | — |   | (190 | ) |
| Net loss                                                                                                                 |       | (20,997                           | )          | (19,371 | ) | (5,059 | ) |
| Preferred stock, Series B warrants  beneficial conversion feature                                                   |       | —                            |       | — |   | (1,976 | ) |
| Preferred stock dividends                                                                                                |       | (500                              | )          | (500 | ) | (500 | ) |
| Net loss applicable to common shares                                                                                     |       | $                                 | (21,497    | ) | $ | (19,871 | ) | $ | (7,535 | ) |
|                                                                                                                     |       |                              |       |   |   |   |   |
| Loss per share:                                                                                                          |       |                              |       |   |   |   |   |
| Basic and diluted loss per share applicable  to common shares before cumulative effect of change in accounting principle |       | $                                 | (0.64      | ) | $ | (0.66 | ) | $ | (0.27 | ) |
| Cumulative effect of change in accounting  principle                                                                     |       | —                            |       | — |   | (0.01 | ) |
| Basic and diluted loss applicable to common  shares                                                                      |       | $                                 | (0.64      | ) | $ | (0.66 | ) | $ | (0.28 | ) |
| Weighted average common shares outstanding –  basic and diluted                                                     |       | 33,665                            |       | 30,143 |   | 27,280 |   |

 

See accompanying notes to the consolidatedfinancial statements.

 

41

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**NEORX CORPORATION AND SUBSIDIARY**

**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** | ** ** | **Shareholder’s  Equity** | ** ** |
|                                                                   |       |                                 |       |                                 |       |                   |       |           |       |                   |       |           |       |   |   |   |   |   |   |
| **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 |   |
| Exercise of stock  options and warrants                                |       | —                               |       | —                               |       | —                 |       | —         |       | 94                     |       | 2              |       | 42 |   | — |   | 44 |   |
|                                                                   |       |                                 |       |                                 |       |                   |       |           |       |                   |       |           |       |   |   |   |   |   |   |
| Common stock  issued, net of offering costs of $337                    |       | —                               |       | —                               |       | —                 |       | —         |       | 3,320                  |       | 66             |       | 3,746 |   | — |   | 3,812 |   |
| Modification of  outstanding employee options                          |       | —                               |       | —                               |       | —                 |       | —         |       | —                 |       |           |       | 6 |   | — |   | 6 |   |
| Stock options  issued for services                                     |       | —                               |       | —                               |       | —                 |       | —         |       | —                 |       | —         |       | (21 | ) | — |   | (21 | ) |
| Comprehensive  loss:                                                   |       | —                               |       |                                 |       |                   |       |           |       |                   |       |           |       |   |   |   |   |   |   |
| Net loss                                                               |       |                                 |       |                                 |       |                   |       |           |       |                   |       |           |       |   |   | (20,997 | ) | (20,997 | ) |
| Unrealized gain  on investment securities                              |       |                                 |       |                                 |       |                   |       |           |       |                   |       |           |       |   |   | 1 |   | 1 |   |
| Total  comprehensive loss                                              |       | —                               |       | —                               |       | —                 |       | —         |       | —                 |       | —         |       | — |   | (20,996 | ) | (20,996 | ) |
| Preferred stock  dividends                                             |       | —                               |       | —                               |       | —                 |       | —         |       | —                 |       | —         |       | — |   | (500 | ) | (500 | ) |
| **Balance,  December 31, 2005**                                   |       | 205                                  |       | $                                    | 4          |                   | 2          |           | $          | —                 |       | 34,323         |       | $ | 686 |   | $ | 258,283 |   | $ | (255,800 | ) | $ | 3,173 |   |

 

See accompanying notes to the consolidated financial statements.

 

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**NEORX CORPORATION AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Cash flows from operating activities:**                                    |       |                              |       |   |   |   |   |
| Net loss                                                                     |       | $                                 | (20,997    | ) | $ | (19,371 | ) | $ | (5,059 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                              |       |   |   |   |   |
| Depreciation and amortization                                                |       | 458                               |       | 800 |   | 793 |   |
| Loss on sale of securities                                                   |       | —                            |       | — |   | 151 |   |
| (Gain) loss on disposal of real estate and equipment                         |       | (137                              | )          | 20 |   | (398) |   |
| Asset impairment loss                                                        |       | 3,346                             |       | — |   | — |   |
| Restructuring                                                                |       | 476                               |       | — |   | — |   |
| Cumulative effect of change in accounting  principle                         |       | —                            |       | — |   | 190 |   |
| Accretion of asset retirement obligation  liability                          |       | —                            |       | — |   | 62 |   |
| Common stock issued for services                                             |       | —                            |       | — |   | 4 |   |
| Stock options and warrants issued for  services                              |       | (21                               | )          | 21 |   | 269 |   |
| Stock-based employee compensation                                            |       | 5                                 |       | 340 |   | 590 |   |
| Change in operating assets and liabilities:                                  |       |                              |       |   |   |   |   |
| Prepaid expenses and other assets                                            |       | 207                               |       | 13 |   | 243 |   |
| Accounts payable                                                             |       | (135                              | )          | 721 |   | 80 |   |
| Accrued liabilities                                                          |       | 331                               |       | (24 | ) | (991 | ) |
| Net cash used in operating activities                                        |       | (16,467                           | )          | (17,480 | ) | (4,066 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Cash flows from investing activities:**                                    |       |                              |       |   |   |   |   |
| Proceeds from sales and maturities of  investment securities                 |       | 1,500                             |       | 10,875 |   | 25,588 |   |
| Purchases of investment securities                                           |       | —                            |       | (33 | ) | (28,408 | ) |
| Facilities and equipment purchases                                           |       | (84                               | )          | (326 | ) | (365 | ) |
| Purchase of licensed product                                                 |       | —                            |       | (1,000 | ) | — |   |
| Proceeds from sales of equipment and  facilities                             |       | 303                               |       | — |   | 1,049 |   |
| Net cash provided by (used in) investing  activities                         |       | 1,719                             |       | 9,516 |   | (2,136 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Cash flows from financing activities:**                                    |       |                              |       |   |   |   |   |
| Repayment of capital lease obligations                                       |       | —                            |       | — |   | (50 | ) |
| Receipt of note receivable principal                                         |       | —                            |       | — |   | 68 |   |
| Repayment of bank note payable principal                                     |       | (339                              | )          | (290 | ) | (1,197 | ) |
| Increase in restricted cash                                                  |       | (1,000                            | )          | — |   | — |   |
| Proceeds from stock options and warrants  exercised                          |       | 44                                |       | 800 |   | 1,872 |   |
| Preferred stock dividends                                                    |       | (500                              | )          | (500 | ) | (500 | ) |
| Proceeds from issuance of common stock and  warrants                         |       | 3,812                             |       | 9,042 |   | 14,611 |   |
| Net cash provided by financing activities                                    |       | 2,017                             |       | 9,052 |   | 14,804 |   |
| Net (decrease) increase in cash and cash  equivalents                        |       | (12,731                           | )          | 1,088 |   | 8,602 |   |
|                                                                         |       |                              |       |   |   |   |   |
| **Cash and cash equivalents:**                                               |       |                              |       |   |   |   |   |
| Beginning of year                                                            |       | 16,254                            |       | 15,166 |   | 6,564 |   |
| End of year                                                                  |       | $                                 | 3,523      |   | $ | 16,254 |   | $ | 15,166 |   |
|                                                                         |       |                              |       |   |   |   |   |
| **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                                                       |       | $                                 | 261        |   | $ | 196 |   | $ | 232 |   |

 

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**NEORX CORPORATION AND SUBSIDIARY**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

***NOTE 1.  Organization and Operations***

 

NeoRxis a biotechnology company dedicated to the development and commercializationof cancer therapy products. The consolidated financial statementsinclude the accounts of NeoRx Corporation and its wholly owned subsidiary,NeoRx Manufacturing Group (Company).

 

TheCompany has historically suffered recurring operating losses and negative cashflows from operations.  As of December 31,2005, the Company had negative net working capital of $1,880,000 and had anaccumulated deficit of $255,800,000 with total shareholders’ equity of$3,173,000.  These consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States, assuming that the Company willcontinue as a going concern.

 

The Company’s total cash andmarketable securities, net of restricted cash of $1,000,000, was $3,523,000 at December 31,2005.  The Company believes that itscurrent cash and cash equivalent balances, including the proceeds of the bridgeloan of $3,460,000, will provide adequate resources to fund operations at leastuntil May 31, 2006.  If the Companydoes not receive required shareholder approvals in connection with the proposedequity financing and complete the proposed equity financing in a timely manner,the Company will not have funds to repay the bridge notes and the Bank notewhen they become due and payable or to fund its continuing operations.  In such case, there is a substantiallikelihood that the Company will be forced to explore liquidation alternatives,including seeking protection from creditors under the bankruptcy laws.

 

See Note 3, “Liquidity andCapital Resources,” for a description of the Company’s February 1, 2006bridge loan and Note 11, “Shareholders’ Equity,” for a description of therelated proposed equity financing.

 

Allinter-company balances and transactions have been eliminated.

 

***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 andExpenses*: Revenues from collaborative agreements are recognized as earned as theCompany performs research activities under the terms of each agreement.Billings in excess of amounts earned are classified as deferred revenue.Pursuant to the Securities and Exchange Commission Staff Accounting Bulletin No. 104,also known as SAB 104, “Revenue Recognition in Financial Statements,”non-refundable upfront technology license fees, where the Company is providingcontinuing services related to product development, are deferred.  Such fees are recognized as revenue over theproduct development periods based on estimated total development costs.  If the Company is not providing continuingservices, revenue is recognized when the payment is due.

 

To date, the Company does not have any significant ongoing revenuesources.  Pursuant to the Securities and Exchange Commission StaffAccounting Bulletin No. 104, “Revenue Recognition,” (SAB 104) and EmergingIssues Task Force Consensus No. 00-21, “Revenue Arrangements with MultipleDeliverables,” (EITF 00-21), which became effective for revenue arrangementsentered into in fiscal periods beginning after June 15, 2003, revenuesfrom sales and licensing of intellectual property and government grants arerecognized as earned. To the extent that a transaction contains multipledeliverables, the Company determines whether the multiple deliverables areseparable, and, if separable, the revenue to be allocated to each deliverablebased on fair value. If fair value is undeterminable for undelivered elementsof the arrangement, revenue is deferred over the contract period or untildelivery, as applicable. The revenue allocated to each deliverable isrecognized following the requirements of SAB 104.

 

44

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Specifically, the Company’s revenue in the periods presented consistedprimarily of the sale and licensing of intellectual property, milestonepayments received, and receipt of government grants. For the sale and licensingof intellectual property and milestone payments, revenue has been recognized aspayments are due as the Company has not had continuing service or otherobligations subsequent to the sale, licensing or milestone payment.  Additionally, milestone payments are based onevents that represent the achievement of substantive steps in the developmentprocess and are believed to represent the fair value of achieving themilestone.  Government grant revenue isrecognized as earned based on completion of performance under the respectivecontracts whereby no ongoing obligation on the part of the Company exists.  Milestone payments are recognized as revenueat the time such payments are due, based on the ratio of cumulative costsincurred 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 as incurred.  It is the Company’s practice to offsetthird-party collaborative reimbursements received as a reduction of researchand development expenses.  Third-partyreimbursements for 2005, 2004, and 2003 were $16,000, $259,000, and $149,000,respectively.

 

*Cash Equivalents*:  All highly liquid investments with anoriginal maturity of three months or less when purchased are considered to becash equivalents.  Cash equivalentsrepresent cash invested primarily in money market funds, federal government andagency securities and corporate debt securities.

 

*InvestmentSecurities:*  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.

 

*Facilitiesand Equipment*:  Facilities and equipmentare stated at acquired cost, less any charges for impairment.  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.

 

*Impairmentof Long-Lived Assets:* Long-lived assets including property and equipment are reviewedfor possible impairment whenever significant events or changes incircumstances, including changes in our business strategy and plans, indicatethat an impairment may have occurred. An impairment is indicated when the sumof the expected future undiscounted net cash flows identifiable to that assetor asset group is less than its carrying value. Impairment losses aredetermined from actual or estimated fair values, which are based on market values,net realizable values or projections of discounted net cash flows, asappropriate.  The Company reviewslong-lived assets annually and on an as needed basis to determine if there havebeen any adverse events or circumstances that would indicate that an impairmentexists.  As a result of these reviews,the Company recorded an impairment charge related to the restructuringactivities during 2005.  See Note 9 forfurther details.

 

*LicensedProducts*:  Licensed Products represent an exclusivelicense to develop, manufacture and commercialize picoplatin, a platinum-basedanti-cancer agent.  Licensed Products areamortized using the straight-line method over their estimated useful life oftwelve years.  The Company evaluates therecoverability of Licensed Products periodically and takes into account eventsor circumstances that might indicate that an impairment exists.  No impairment of Licensed Products wasidentified during 2005.

 

*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 

 

45

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forwards.  A valuation allowanceis established when necessary to reduce deferred tax assets to the amount, ifany, which is expected more likely than not to be realized.

 

*Net LossPer Common Share*:  Basic and diluted lossper share are based on net loss applicable to common shares, which is comprisedof net loss, beneficial conversion feature and preferred stock dividends in allperiods presented. Shares used to calculate basic loss per share are based onthe weighted average number of common shares outstanding during theperiod.  Shares used to calculate dilutedloss per share are based on the potential dilution that would occur upon theexercise or conversion 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.

 
| ** **             | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Common Stock  options  |       | 4,324,000 |       | 3,528,000 |       | 4,103,000 |       |
| Common Stock  warrants |       | 3,225,000 |       | 1,588,000 |       | 1,505,000 |       |

 

Additionally, aggregateshares of 3,446,389 and 234,088 issuable as of December 31, 2005 uponconversion of the Company’s Series B convertible preferred stock and Series 1convertible exchangeable preferred stock, respectively, are not included in thecalculation of diluted loss per share for 2005, 2004 and 2003 because the shareincrements would not be dilutive.

 

*StockOption Plans: *The Company accounts for its stockoption plans for employees in accordance with the provisions of AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations, including FASB Interpretation No. 44,Accounting for Certain Transactions Involving Stock Compensation, aninterpretation of APB Opinion No. 25. Compensation expense related to employee stock options is recorded if,on the date of grant, the fair value of the underlying stock exceeds theexercise price.  The Company applies thedisclosure-only requirements of SFAS No. 123, “Accounting for Stock-BasedCompensation” and SFAS No. 148, “Accounting for Stock-BasedCompensation–Transition and Disclosure, an amendment of FASB Statement No. 123,”which allows entities to continue to apply the provisions of APB Opinion No. 25for transactions with employees and to provide pro forma results of operationsdisclosures for employee stock option grants as if the fair-value based methodof accounting in SFAS 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 periodof benefit.

 

Had compensation cost forthese stock option plans been determined using the fair value based method ofaccounting under SFAS 123, “Accounting for Stock-Based Compensation,” theCompany’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,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss applicable to common shares:                                                              |       |                             |       |   |   |   |   |
| As reported                                                                                        |       | $                                | (21,497    | ) | $ | (19,871 | ) | $ | (7,535 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss                      |       | 5                                |       | 340 |   | 590 |   |
| Deduct: Stock-based employee compensation  determined under fair value based method for all awards |       | (1,189                           | )          | (1,666 | ) | (2,688 | ) |
| Pro forma                                                                                          |       | $                                | (22,681    | ) | $ | (21,197 | ) | $ | (9,633 | ) |
| Loss per common share, basic and diluted:                                                          |       |                             |       |   |   |   |   |
|   As  reported                                                                                |       | $                                | (0.64      | ) | $ | (0.66 | ) | $ | (0.28 | ) |
|   Pro  forma                                                                                  |       | $                                | (0.67      | ) | $ | (0.70 | ) | $ | (0.35 | ) |

 

46

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The per share weighted-average fair value of stock options grantedduring 2005, 2004 and 2003, was $0.77, $1.87, and $1.02, respectively, on thegrant date using the Black-Scholes option pricing model with the followingassumptions:

 
| ** **              | ** ** | **Year ended December 31,** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected dividend rate  |       | 0.0                              | %          | 0.0 | % | 0.0 | % |
| Risk-free interest rate |       | 3.87                             | %          | 3.43 | % | 2.30 | % |
| Expected volatility     |       | 122.9                            | %          | 120.9 | % | 135.7 | % |
| Expected life in years  |       | 4.00                             |       | 4.00 |   | 4.00 |   |

 

*Concentrationin the Available Sources of Supply of Materials*: For the Company’s picoplatin product candidate to be successful, theCompany needs sufficient, reliable and affordable supplies of the picoplatindrug product.  Sources of picoplatin drugproduct may be limited, and third-party suppliers of picoplatin drug productmay be unable to manufacture drug product in amounts and at prices necessary tosuccessfully commercialize the Company’s picoplatin product.  Moreover, third-party manufacturers mustcontinuously adhere to current Good Manufacturing Practice (cGMP) regulations enforced by the FDA through itsfacilities inspection program. If the facilities of these manufacturers cannotpass a pre-approval plant inspection, the FDA will not grant a New DrugApplication (NDA) for the Company’s proposed products. In complying with cGMPand foreign regulatory requirements, any of our third-party manufacturers willbe obligated to expend time, money and effort in production, record-keeping andquality control to assure that the Company’s products meet applicablespecifications and other requirements. If any of the Company’s third-partymanufacturers fails to comply with these requirements, the Company may besubject to regulatory action.

 

TheCompany entered into an agreement with Hyaluron, Inc. to manufacture andsupply picoplatin drug product on a purchase order, fixed fee basis.  The agreement will continue until April 15,2010, subject to earlier termination by either party in the event of an uncuredmaterial breach or the liquidation or bankruptcy of the other party.  The Company may terminate the agreement if itdecides to no longer pursue manufacturing or distribution of picoplatin. Thereis no assurance that Hyaluron will be able to provide sufficient supplies ofpicoplatin drug product on a timely or cost-effective basis.   There are in general relatively fewmanufacturers and suppliers of picoplatin drug product. If Hyaluron or analternate manufacturer is unable or unwilling to manufacture and provide drugproduct at a cost and on other terms acceptable to the Company, the Company maysuffer delays in, or be prevented from, initiating or completing its clinicaltrials of picoplatin.

 

*Fair Value of Financial Instruments*:  The Company has financial instrumentsconsisting of cash, cash equivalents, restricted cash, investment securities,notes receivable, accounts payable and notes payable.  The fair value of all of the Company’sfinancial instruments, based on either the short-term nature of the instrument,current market indicators or quotes from brokers, approximates their carryingamount.

 

*SegmentReporting:*  The Company has one operating businesssegment.

 

*New AccountingPronouncements*:  In May 2005, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards (SFAS) No. 154, “AccountingChanges and Error Corrections, a Replacement of APB Opinion No. 20 andFASB Statement No. 3.”  SFAS 154 establishes, unlessimpracticable, retrospective application as the required method for reporting achange in accounting principle in the absence of explicit transitionrequirements specific to a newly adopted accounting principle. Previously, mostchanges in accounting principle were recognized by including the cumulativeeffect of changing to the new accounting principle in net income of the periodof the change. Under SFAS 154, retrospective application requires (i) thecumulative effect of the change to the new accounting principle on periodsprior to those presented to be reflected in the carrying amounts of assets andliabilities as of the beginning of the first period presented, (ii) anoffsetting adjustment, if any, to be made to the opening balance of retainedearnings (or other appropriate components of equity) for that period, and (iii) financialstatements for each individual prior period presented to be adjusted to reflectthe direct period-specific effects of applying the new accounting principle.Special retroactive application rules apply in situations where it isimpracticable to determine either the period-specific effects or the 

 

47

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cumulativeeffect of the change. Indirect effects of a change in accounting principle are required to bereported in the period in which the accounting change is made.  SFAS 154 carries forward the guidance inAPB Opinion 20 “Accounting Changes,” requiring justification of a change inaccounting principle on the basis of preferability.  SFAS 154 also carries forward without changethe guidance contained in APB Opinion 20, for reporting the correction ofan error in previously issued financial statements and for a change in anaccounting estimate. SFAS 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005. The Company does not expect SFAS 154 will significantly impact itsfinancial statements upon its adoption on January 1, 2006.

 

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-BasedCompensation,” issued in 1995. SFAS 123R requires that the fair value of thegrant of employee stock options be reported as an expense in the results of operations.  SFAS 123Reliminates the ability to account for stock-based compensation usingAPB 25 and requires that such transactions be recognized as compensationcost in the income statement based on their fair values on the measurementdate, which is generally the date of the grant. The Statement is effective for the first annual reporting periodthat begins after June 15, 2005. Historically, the Company has disclosed in its footnotes the pro formaexpense effect of the grants.   Stock compensation expense underthe prior rules would have increased reported diluted loss per share by$.03 in 2005.  SFAS 123R willapply to all outstanding, unvested option grants as of the effective date.  The Company plans to adopt SFAS No. 123Reffective beginning in the first quarter of 2006 using the Modified Prospectivemethod.  Under the Modified Prospectivemethod, SFAS 123R applies to new and modified option grants after the effectivedate, and to any unvested option grants as service is rendered on or after theeffective date.  The attribution of compensation cost for vested option grants as of thedate of adoption will be based on the same method and on the same grant-datefair values previously determined for the pro forma disclosures required forcompanies that did not adopt the fair value accounting method for stock-basedemployee compensation. Based on the stock-based compensation awards outstandingas of December 31, 2005 for which the requisite service is not expected tobe fully rendered prior to January 1, 2006, the Company expects torecognize total annual compensation cost in 2006 of approximately$320,000 to $630,000 resulting from the adoption of SFAS 123R.  Futurelevels of compensation cost recognized related to stock-based compensationawards (including the aforementioned expected costs during the period ofadoption) will be impacted by new awards and/or modifications, repurchases andcancellations of existing awards before and after the adoption SFAS 123R.

 

#### **NOTE 3.   Liquidity andCapital Resources**

#### ** **

TheCompany has financed its operations primarily through the sale of equitysecurities, technology licensing, collaborative agreements and debtinstruments.  The Company invests excesscash in investment securities that will be used to fund future operatingcosts.  Cash, cash equivalents andinvestment securities, net of restricted cash of $1,000,000, totaled $3,523,000at December 31, 2005 compared to $17,753,000 at December 31,2004.  The Company primarily fundscurrent operations with its existing cash and investments.  Cash used for operating activitiesfor the twelve months ended December 31, 2005 totaled $16,468,000.** **This included$1,300,000 in costs incurred as part of the STR restructuring.  Revenues and other income sources for 2005were not sufficient to cover operating expenses.

 

The Company raisedapproximately $3,800,000 in net proceeds from the sale of common stock andwarrants in a private placement transaction in March 2005.  The Company has applied the net proceeds fromthis financing to support its Phase II trial in picoplatin in small cell lungcancer and for general working capital, including restructuring costsassociated with the termination of its STR development program. The Companyraised approximately $9,000,000 in net proceeds from the sale of common stockand warrants in a private placement transaction in February 2004.  The net proceeds from this financing wereused to support the Company’s STR development program, which the Companydiscontinued in May 2005, and for general working capital.

 

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OnFebruary 1, 2006, the Company received a $3,460,000 bridge loan (“bridgeloan”) from investors in the proposed equity financing described in Note 11 ofthese Notes to Financial Statements. Pursuant to the bridge loan, the Company issued convertible promissorynotes for the principal amount of the loan and five-year warrants to purchasean aggregate of approximately 2,500,000 shares of common stock at an exerciseprice of $0.77 per share.  The proceedsof the bridge loan will be used for working capital while the Company seeks toobtain required shareholder approvals to complete the proposed equityfinancing.  The bridge notes have aninterest rate of 8% per annum and, if the proposed equity financing is approvedby Company shareholders and closes, automatically would convert into anaggregate of approximately 5,000,000 shares of common stock.  The notes are secured by a first lien oncertain of the Company’s assets pursuant to a security agreement between theCompany and the investors dated as of February 1, 2006.  The bridge notes will mature on the earliestof (i) May 31, 2006, (ii) the closing of the proposed equityfinancing, and (iii) the written election of the holders of 60% ininterest of the principal amount of the bridge notes following an event ofdefault under the terms of the bridge notes. If the proposed equity financing is not completed on or before May 31,2006, or there occurs an event of default under the bridge notes, or the ifbridge notes are outstanding after May 31, 2006, the principal amount ofthe bridge notes and all accrued and unpaid interest may, subject to certainlimitations, be converted at the option of the investors into shares of commonstock at the lesser of (i) $0.70 per share or (ii) the greater of:(X) $0.45 per share or (Y) the closing per share bid price on the date of theevent of default or May 31, 2006, as applicable.  Unless previously converted, the outstandingprincipal balance and all accrued and unpaid interest under the bridge noteswill, after the maturity date, bear interest at an increased rate of 13% fromand after the date of default to the date of payment in full of the unpaidamount.

 

Asa condition to closing of the bridge loan, the Company executed a letteragreement dated January 30, 2006 with Texas State Bank, pursuant to whichthe Company agreed to change the maturity date of its promissory note with theBank from April 17, 2009 to June 5, 2006. The Company originally entered into a the Bank note in connection withits 2001 purchase of a radiopharmaceutical manufacturing plant and other assetslocated in Denton, Texas.  As part ofthat transaction, the Company assumed $6,000,000 principal amount ofrestructured debt held by Texas State Bank, McAllen, Texas.  The loan is secured by the assets acquired inthe transaction.  The interest rate onthe loan was 7.25% on December 31, 2005. The loan provides for a maximum annual interest rate of 18%.  Principal and interest are payable in monthlyinstallments.  Principal and interestpaid on the note during the years ended December 31, 2005 and 2004 totaled$601,000 and $486,000, respectively. With the implementation of therestructuring plan in May 2005 (see Note 8), the Company began sellingexcess equipment previously used in the manufacturing facility.  Under the terms of the note, certain proceedsfrom the sale of such equipment in 2005 ($115,000) were applied against theprincipal balance of the note.  The fixedmonthly payments on the note are recalculated in April of each year basedon the then current bank prime interest rate and outstanding note balance.  Based on an interest rate of 7.50% (effectiveJanuary 31, 2006) and taking into account the early payment of$1,000,000 in principal under the arrangement described below, the estimatedprincipal balance payable at maturity would be approximately $2,700,000.

 

Theterms of the Bank loan provide that an event of default may be deemed to occurif the Company abandons, vacates or discontinues operations on a substantialportion of the Denton facility or there is a material adverse change in itsfinancial condition, results of operations, business or properties. If thiswere to occur, the Bank could declare the entire amount of the loan due andimmediately payable.  In such case, itscash resources and assets could be impaired depending on its ability to raisefunds through a sale of the Denton facility or other means.  As a result of the restructuring and thedecision to discontinue its STR development program, the Company has ceasedmanufacturing operations at the Denton facility and is actively working to sellthe facility and other STR assets. The Company has listed the Denton facilityfor sale at a price of $3,300,000.  Anysales of the Denton facility or other Denton assets are subject to approval ofthe Bank.  As of December 31, 2005,the Company received aggregate proceeds of $115,000 from the sale of equipmentand other assets.  These proceeds wereapplied to the outstanding principal balance of the loan.  There can be no assurance that the Bank willapprove the price or other terms of any offer received by the Company to buythe Denton facility or other STR assets, or that the sale proceeds, if any,received by the Company from such sales will be sufficient to satisfy theoutstanding balance of the Bank loan.

 

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InOctober 2005, the Company placed $1,000,000 in cash in a restricteddeposit account with the Bank as additional collateral to secure the payment ofthe loan.  The Company further agreed thatif the Company were unable to obtain at least $15,000,000 in new financing onor before January 31, 2006, the Bank may apply the $1,000,000 cash depositto the payment of the last maturing installments on the loan.  In return, the Bank agreed that its cessationof operations at the Denton facility will not be declared an event of defaultunder the loan as long as the Company continues to pay insurance and taxes onand otherwise maintain the facility. Additionally, the Bank agreed, prior to January 31, 2006, not todeclare the loan in default on the basis that there has been a material adversechange in its financial condition, results of operations, business orproperties. Pursuant to this agreement, the Bank, as of January 31, 2005,applied the $1,000,000 cash collateral and all interest accrued thereon to theoutstanding balance of the Bank note.  Byletter agreement dated as of January 30, 2006 the Bank agreed, in exchangefor its agreement to accelerate the maturity date of the note, to continue theforbearance under the October 2005 agreement until June 5, 2006.

 

OnAugust 4, 2005, the Company entered into a Research Funding and OptionAgreement with The Scripps Research Institute, or TSRI.  Under the agreement, the Company has agreedto provide TSRI an aggregate of $2,500,000 over a 26-month period to fundresearch relating to synthesis and evaluation of novel small molecule,multi-targeted protein kinase inhibitors as therapeutic agents, including forthe treatment of cancer.  The Company hasthe option to negotiate a worldwide exclusive license to use, enhance anddevelop any compounds arising from the collaboration.  The research funding is payable by theCompany to TSRI quarterly in accordance with a negotiated budget.  The Company made an initial funding paymentto TSRI of $137,500 on August 8, 2005, and the Company is obligated tomake additional aggregate funding payments of $1,000,000 and $1,400,000 in 2006and 2007, respectively.

 

TheCompany believes that its current cash and cash equivalent balances, includingthe proceeds of the bridge loan, will provide adequate resources to fundoperations at least until May 31, 2006. If the Company does not receive required shareholder approvals inconnection with the proposed equity financing and complete the proposed equityfinancing in a timely manner, the Company will not have funds to repay thebridge notes and the Bank note when they become due and payable or to fund itscontinuing operations.  In such case,there is a substantial likelihood that the Company will be forced to exploreliquidation alternatives, including seeking protection from creditors under thebankruptcy laws.

 

TheCompany acquired the worldwide exclusive rights, excluding Japan, to develop,manufacture and commercialize picoplatin from AnorMED, Inc. in April 2004.  Under the terms of the agreement, the Companypaid AnorMED a one-time upfront milestone payment of $1,000,000 in common stockand $1,000,000 in cash.  The agreementalso provides for additional milestone payments to AnorMED of up to$13,000,000, payable in cash or a combination of cash and common stock.  Upon regulatory approval, AnorMED wouldreceive royalty payments of up to 15% on product sales.  The Company initiated its first picoplatinclinical trial, a Phase II study of picoplatin in small cell lung cancer, in July 2005,and it is unlikely that these milestones would be triggered during 2006.  Because the Company cannot predict the lengthof time to completion of its Phase II study, the time of initiation and completionof a Phase III study or the time of submission of a New Drug Application forpicoplatin, the Company is unable to predict when such milestones might betriggered after 2006.

 

Alsoin April 2004, the Company sold and transferred its Pretarget intellectualproperty to Aletheon Pharmaceuticals, Inc. Under the agreement, the Company could receive up to $6,600,000 inmilestone payments if Aletheon achieves certain development goals, plusroyalties on potential future product sales. The Company did not receive any upfront consideration for the sale ofthe Pretarget property.  The Companydiscontinued its clinical studies using the Pretarget technology in July 2002,and sought, both through targeted inquiries and a broad-based auction process,a buyer or licensee for the technology. The sale of the Pretarget intellectual property relieved the Company ofthe annual costs associated with maintaining the Pretarget patent estate.  During 2003, the Company spent approximately$350,000 for the prosecution and maintenance of the Pretarget patents andtrademarks.  For 2004, these costs wereapproximately $70,000.  Seattle-basedAletheon is a development stage biotherapeutics company founded by two formerNeoRx employees.  The timing and amountof milestone payments, if any, are uncertain. The terms of the transaction were determined through arms-lengthnegotiation.

 

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InApril 2003, the Company received $10,000,000 from the sale to BostonScientific Corporation, or BSC, of certain non-core patents and patentapplications and the grant to BSC of exclusive license rights to certainpatents and patent applications.  BSCoriginally asserted its such patents in two lawsuits against Johnson &Johnson, Inc., its subsidiary, Cordis Corporation, and GuidantCorporation, alleging infringement of such patents.** **In both lawsuits, the defendantsdenied infringement and asserted invalidity and unenforceability of thepatents.  BSC subsequently withdrew threeof the patents from the litigation, including the patents that were assigned toBSC. The Company understands that BSC is still asserting a licensed patentagainst the defendants, but has also agreed, in principle, to purchaseGuidant.  Although the Company is notcurrently a party to the lawsuits, its management and counsel have been deposedin connection with the lawsuits.  It ispossible that BSC, if it is unsuccessful or has limited success with itsclaims, may seek damages from us, including recovery of all or a portion of theamounts it paid to the Company in 2003. The Company cannot assess the likelihood of whether such claim will bebrought against the Company or the extent of recovery, if any, on any suchclaim.

 

Althoughthere can be no assurance, if the Company completes the proposed equityfinancing described in Note 11 the Company will require substantial additionalfunding to develop and commercialize picoplatin and any other proposed productsand to fund its operations.

 

TheCompany is continuously exploring alternatives, including:

 

•      raisingadditional capital through the public or private sale of equity or debtsecurities or through the establishment of credit or other funding facilities;and

 

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

 

TheCompay’s actual capital requirements will depend upon numerous factors,including:

 

•      the scopeand timing of its picoplatin clinical program and other research anddevelopment efforts, including the progress and costs of its Phase II trial ofpicoplatin in small cell lung cancer;

 

•      itsability to obtain clinical supplies of picoplatin drug product in a timely andcost effective manner;

 

•      actionstaken by the FDA and other regulatory authorities;

 

•       thetiming and amounts of proceeds from any sale of the Denton facility and assets;

 

•      itsalternatives with respect to the STR assets, including any potentialdisposition or out-licensing alternatives and the timing, type and amount ofconsideration received and other terms of any such transactions;

 

•      thetiming and amount of any milestone or other payments the Company might receivefrom or pay to potential strategic partners;

 

•      its degreeof success in commercializing picoplatin or any other cancer therapy productcandidates;

 

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

 

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

 

•      the costsof any research collaborations or strategic partnerships established, if the 

 

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            Companychooses to pursue such activities; and

 

•      the costsof preparing, filing, prosecuting, maintaining and enforcing patent claims andother intellectual property rights.

 

Therecan be no assurance that the Company will be able to obtain needed additionalcapital or enter into relationships with corporate partners on a timely basis,on favorable terms, or at all. Conditions in the capital markets in general and the life sciencecapital market specifically may affect the Company’s potential financingsources and opportunities for strategic partnering.  See Note 1.

 

#### **Note 4. Restricted Cash**

#### ** **

AtDecember 31, 2004, no cash was restricted as to usage or withdrawal, while$1,000,000, in the form of a certificate of deposit was restricted at December 31,2005.  Under the terms of the Company’s October 2005letter agreement with Texas State Bank, the $1,000,000 served as additionalcollateral to secure the payment of the Company’s loan with Texas StateBank.  The Company further agreed that ifthe Company was unable to obtain at least $15,000,000 in new financing on orbefore January 31, 2006, the Bank may apply the $1,000,000 cash deposit tothe payment of the last maturing installments on the loan.  Pursuant to this agreement, the Bank, as of January 31,2005, applied the $1,000,000 cash collateral and all interest accrued thereonto the outstanding balance of the Bank note.

 

#### **NOTE 5.  InvestmentSecurities**

 

A summary of available-for-sale investments is as follows:

 
| ** **                                | ** ** | ** ** | ** ** | **Gross Unrealized** | ** ** | **Estimated   Fair Value** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **Cost**   | ** ** | **Gains**            | ** ** | **(Losses)**               | ** ** | ** ** |
| December 31,  2004                   | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Federal  government and agency securities |       | 1,500      |       | —               |       | (1                         | )          | 1,499 |   |

 

The Company did not own any investmentsecurities as of December 31, 2005. At December 31, 2004, the federalgovernment security with the estimated fair value of approximately $1,499,000matured during the first quarter of 2005. There was no gross gain or lossrealized for this maturity.

 

#### **NOTE 6.  Accrued Liabilities**

 
| Accrued liabilities  consist of the following (in thousands): | ** ** |
|---------------------------------------------------------------|------------|
|                                                          | ** ** |
| ** **                                                    | ** ** | **December 31,** | ** ** |
| ** **                                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Accrued  expenses                                             |       | $ | 736 |   | $ | 486 |   |
| Compensation                                                  |       | 743 |   | 542 |   |
| Restructuring                                                 |       | 217 |   | — |   |
| Decommissioning  costs                                        |       | 73 |   | 194 |   |
| Severance                                                     |       | 250 |   | — |   |
| Other                                                         |       | 59 |   | 49 |   |
|                                                          |       | $ | 2,078 |   | $ | 1,271 |   |
|                                                               |            |  |  |  |  |  |  |  |

 

#### **NOTE 7.  Note Payable**

#### ** **

Inconnection with the Company’s 2001 purchase of the radiopharmaceuticalmanufacturing plant and other assets located in Denton, Texas, the Companyassumed $6,000,000 principal amount of restructured debt held by Texas StateBank, McAllen, Texas.  The loan, whichmatures in June 2006, is secured by the assets acquired in thetransaction.  The interest rate on theloan was 7.25% on December 31, 2005. The interest rate is equal to the bank prime rate and is adjusted on thesame date that the 

 

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bankprime rate changes as reported in the Wall Street.  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 the years ended December 31,2005 and 2004 totaled $601,000 and $486,000, respectively. The fixed monthlypayments on the note are recalculated in April of each year based on thethen current bank prime interest rate and outstanding note balance.  Based on an interest rate of 7.25% (effectiveDecember 31, 2005) and taking into account the early payment of $1,000,000in principal under the arrangement described below, the estimated principalbalance payable at maturity would be $2,700,000.

 

Asof December 31, 2005, the outstanding balance of the loan was $3,868,000,all of which matures in June 2006.

 

The terms of the Texas StateBank loan provide that an event of default may be deemed to occur if theCompany abandons, vacates or discontinues operations on a substantial portionof the Denton facility or there is a material adverse change in the Company’sfinancial condition, results of operations, business or properties. If thiswere to occur, Texas State Bank could declare the entire amount of the loan dueand immediately payable.  In such case,our cash resources and assets could be impaired depending on our ability toraise funds through a sale of the Denton facility or other means.  As a result of the restructuring and thedecision to discontinue its STR development program, the Company ceasedmanufacturing operations at the Denton facility and is actively working to sellthe facility and other STR assets. The Company has listed the Denton facilityfor sale at a price of $3,300,000.  Anysales of the Denton facility or other Denton assets are subject to approval ofthe Bank.  As of December 31, 2005,the Company received aggregate proceeds of $115,000 from the sale of equipmentand other assets.  These proceeds wereapplied to the outstanding principal balance of the loan.  There can be no assurance that the Bank willapprove the price or other terms of any offer received by the Company to buythe Denton facility or other STR assets, or that the sale proceeds, if any,received by us from such sales will be sufficient to satisfy the outstandingbalance of the Bank loan.

 

In October 2005, theCompany placed $1,000,000 in cash in a restricted deposit account with the Bankas additional collateral to secure the payment of the loan.  The Company further agreed that if it wasunable to obtain at least $15,000,000 in new financing on or before January 31,2006, the Bank may apply the $1,000,000 cash deposit to the payment of the lastmaturing installments on the loan.  Inreturn, the Bank agreed that the Company’s cessation of operations at theDenton facility will not be declared an event of default under the loan as longas we continue to pay insurance and taxes on and otherwise maintain thefacility.  Additionally, the Bank agreed,prior to January 31, 2006, not to declare the loan in default on the basisthat there has been a material adverse change in the Company’s financialcondition, results of operations, business or properties.  Pursuant to this agreement, the Bank, as ofJanuary 31, 2005, applied the $1,000,000 cash collateral and all interestaccrued thereon to the outstanding balance of the Bank note.  By letter agreement dated as of January 30,2006, the Bank agreed, in exchange for the Company’s agreement to acceleratethe maturity date of the note, to continue the forbearance under the October 2005agreement until June 5, 2006.

 

# **NOTE 8. Restructuring**

# ** **

In May and June 2005,the Company restructured its operations and reduced its work force byapproximately 50% in connection with the implementation of its restructuringplan to refocus its resources on the development of picoplatin (NX 473) anddiscontinue its skeletal targeted radio therapy (STR) development program.  The employees terminated as part of thereduction of staff were no longer with the Company at December 31, 2005and will not be providing future services to the Company.  The Company incurred termination benefitscharges of totaling $892,000 related to the reduction in staff in May and June 2005.  Of this amount, $250,000 remained unpaid asof December 31, 2005 and is included in accrued expenses in the balancesheet.  This amount is payable within oneyear.  The Company incurred additionalnon-employee charges totaling $612,000 related to the discontinuation of itsSTR clinical trials and the closure of its radiopharmaceutical manufacturingplant and STR research facilities, primarily consisting of contract terminationand decommissioning costs.  The Companyrecorded additional charges of $237,000 for decommissioning costs during thethird and fourth quarters of 2005 due to anticipated increased waste disposalcosts at its radiopharmaceutical manufacturing plant in Denton, Texas andanticipated increased STR study finalization costs.  Total non-employee charges totaled$849,000.  Of this amount, $217,000remained unpaid as of December 31, 2005 and is included in accruedexpenses in the balance sheet.  Thisamount is payable within one year.

 

In conjunctionwith our strategic restructuring, in June 2005 we negotiated the earlytermination of our STR-related supply agreement with the University of MissouriResearch Reactor facility group (MURR). We paid MURR a fee of $368,000 in connection with such earlytermination.  During 2005 we paid$190,000 in minimum purchase requirements under the agreement.  These two amounts are included in thenon-employee charges of $612,000 discussed above.

 

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Thefollowing table summarizes the change in the restructuring accrual from initialrecognition through December 31, 2005:

 
| **Description**               | ** ** | **Initial  Restructuring  Charge** | ** ** | **Adjustment   of   Restructuing  Charge** | ** ** | **Restructuring  Charge** | ** ** | **Payment of   Restructuring  Obligations** | ** ** | **Accrued   Restructuring  Charge as of   December 31,  2005** | ** ** |
|-------------------------------|------------|------------------------------------|------------|--------------------------------------------|------------|---------------------------|------------|---------------------------------------------|------------|---------------------------------------------------------------------|------------|
|                          |       |                               |       |                                       |       |                      |       |                                        |       |                                                                |       |
| Employee termination benefits |       | $                                  | 892,000    |                                       | $          | —                    |       | $                                           | 892,000    |                                                                | $          | (642,000 | ) | $ | 250,000 |   |
| Contract termination costs    |       | 378,000                            |       | (10,000                                    | )          | 368,000                   |       | (366,000                                    | )          | 2,000                                                               |       |
| Other termination costs       |       | 234,000                            |       | 247,000                                    |       | 481,000                   |       | (266,000                                    | )          | 215,000                                                             |       |
| Sub-total                     |       | 612,000                            |       | 237,000                                    |       | 849,000                   |       | (632,000                                    | )          | 217,000                                                             |       |
| Total                         |       | $                                  | 1,504,000  |                                       | $          | 237,000                   |       | $                                           | 1,741,000  |                                                                | $          | (1,274,000 | ) | $ | 467,000 |   |

 

# **NOTE 9.  Asset Impairment Loss**

# ** **

InJune 2005, the Company recognized an asset impairment loss of $3,346,000on certain facilities and equipment resulting from the Company’s decisions toterminate its STR program. The loss on the Denton manufacturing facility andrelated equipment was determined based on an appraisal study commissioned bythe Company, as well as management reviews with the assistance of outsidecommercial real estate brokers.  TheCompany used a fair value of $3,300,000 for the Denton facility in determiningthe impairment loss.  This valuation wasthe result of weighting the range of values in the appraisal study, whichvaried from $3,100,000 to $5,000,000. The loss on the equipment at the Seattlefacility was determined based on estimates of potential sales values of usedequipment.  These impairment chargesestablished new cost bases for the impaired assets, which are reported inAssets Held for Sale and other current assets on the accompanying CondensedConsolidated Balance Sheets.  The Companyis actively seeking a buyer for the Denton facility and its STR relatedassets.  However, given the inherentuncertainty of the timing of a sale of the Denton facility, the Companyclassified this asset as long term.

 

Thefollowing table summarizes information related to the impairment charges:

 
| **Description**                                      | ** ** | **Impairment Loss** | ** ** | **Impaired  Carrying Value  as of June 30,  2005** | ** ** | **Disposals of   Assets** | ** ** | **Post  Impairment Carrying   Value  as of   December 31, 2005** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|---------------------------------------------------------|------------|---------------------------|------------|-----------------------------------------------------------------------|------------|
|                                                 |       |                |       |                                                    |       |                      |       |                                                                  |       |
| Equipment –  Seattle, WA                        |       | $                   | 155,000    |                                                    | $          | 45,000                    |       | $                                                                     | (44,000    | ) | $ | 1,000 |   |
| Equipment –  Manufacturing Facility, Denton, TX |       | 589,000             |       | 183,000                                                 |       | (101,000                  | )          | 82,000                                                                |       |
| Manufacturing  Facility - Denton, TX                 |       | 2,602,000           |       | 3,027,000                                               |       | —                    |       | 3,027,000                                                             |       |
| Total                                                |       | $                   | 3,346,000  |                                                    | $          | 3,255,000                 |       | $                                                                     | (145,000   | ) | $ | 3,110,000 |   |

 

#### **NOTE 10.  Leases andCommitments**

#### ** **

*Leases. *The lease agreements for theCompany’s principal locations expire in 2006 and 2009.  Total rent expense under operating leases wasapproximately $744,000, $673,000, and $722,000 for 2005, 2004 and 2003,respectively.

 

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Minimum lease paymentsunder operating leases as of December 31, 2005 are as follows (inthousands):

 
| **Year**                      | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| 2006                          |       | $          | 630        |   |
| 2007                          |       | 579        |       |
| 2008                          |       | 559        |       |
| 2009                          |       | 326        |       |
| Thereafter                    |       | —     |       |
| Total  minimum lease payments |       | $          | 2,094      |   |

 

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

#### ** **

*CommonStock Transactions*:  On February 1, 2006, the Company enteredinto a definitive agreement with institutional and other accredited investorsfor a $65,000,000 private placement of newly issued shares of the Company’scommon stock and the concurrent issuance of warrants for the purchase ofadditional shares of common stock (the proposed equity financing).  The closing of the proposed equity financing,including the issuance of the securities and the receipt of proceeds, issubject to shareholder approval in accordance with Nasdaq Marketplace Rules, aswell as to satisfaction of customary and other conditions of closing, includingshareholder approval of an amendment to the Company’s articles of incorporationto increase the number of authorized shares of common stock in order to providefor a sufficient number of shares to complete the proposed equityfinancing.  A special meeting ofshareholders to vote on these matters is scheduled to be held of April 11,2006.

 

Inconnection with the proposed equity financing, on February 1, 2006, theholders of all of the Company’s outstanding shares of Series B convertiblepreferred stock executed an agreement, subject to the closing of the proposedequity financing, to convert their shares of Series B preferred stock intoshares of common stock, at an adjusted conversion rate of 6060.6061 commonshares for each Series B preferred share. Subject to shareholder approval of the proposed financing and theproposed amendment of the Company’s articles of incorporation, the Companywould, concurrently with the closing of the equity financing, issue to holdersof the Series B preferred sock an aggregate of approximately 9,500,000shares of common stock in such conversion.  The agreement to convert expires on the earliest to occur of (i) anyevent pursuant to which all of the outstanding shares of Series Bpreferred stock are converted into shares of common stock; (ii) consummationof a liquidation (as that term is defined in Section 3(d) of the Series BDesignation); and (iii) June 1, 2006.

 

Inconnection with the proposed equity financing, the Company executed a note andwarrant purchase agreement dated as of February 1, 2006, pursuant to whichthe Company issued convertible promissory notes in favor of the investors inreturn for a short-term bridge loan in the aggregate principal amount of$3,460,000.  In addition to the bridge notes,the Company issued the investors five-year warrants to purchase an aggregate ofapproximately 2,500,000 shares of the Company’s common stock at an exerciseprice of $0.77 per share.  The proceedsof the bridge loan will be used to fund the Company’s operations while theCompany seeks shareholder approval of the proposed equity financing.  As a condition to the closing of the bridgeloan, the Company entered into a letter agreement dated January 30, 2006with Texas State Bank extending the original term of the October 2005forbearance letter between the Bank and the Company to June 5, 2006, andchanging the maturity date of the Company’s promissory note with the Bank to June 5,2006.

 

In March 2005, theCompany raised approximately $3,812,000 in net proceeds through the sale in aprivate placement (the 2005 financing) of 3,320,000 shares of commonstock.  In connection with the 2005financing, 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.  In addition, the placement agent in the 2005financing was granted a warrant, on the same terms as those received by thepurchasers in that transaction, for 199,200 shares of common stock.  The Company has registered the shares ofcommon stock issued in the 2005 financing, and the shares of common stockissuable upon exercise of the related warrants, with the SEC.

 

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In April 2004, theCompany issued 244,000 shares of common stock valued at $1,000,000 as a partialpayment to purchase an exclusive license to develop, manufacture andcommercialize picoplatin , a platinum-based anti-cancer agent.  The 244,000 shares of common stock issued inthis licensing arrangement have been registered with the SEC.

 

In February 2004, theCompany raised approximately $9,000,000 in net proceeds through the sale in aprivate placement (the 2004 financing) of 1,845,000 shares of commonstock.  In connection with the 2004financing, the Company issued five-year warrants to purchase an aggregate of922,500 shares of common stock at $7.00 per share.  The 1,845,000 shares of common stock issuedin the 2004 financing, and the shares of common stock issuable upon exercise ofthe warrants related thereto, have been registered with the SEC.

 

During 2005, the Companyreceived approximately $44,000 in net proceeds from the issuance of 94,000shares of common stock related to the exercises of employee stock options.

 

During 2004, the Companygenerated approximately $800,000 in net proceeds from the issuance of 817,000shares of common stock related to the exercises of employee stock options.

 

During 2003, the Companyreceived approximately $1,872,000 in net proceeds from the issuance of1,188,000 shares of common stock related to the exercises of employee stockoptions.  Also during 2003, the Companyissued 70,000 shares of common stock to officers as payment for a portion ofbonus expense accrued as of December 31, 2002, and issued 10,000 shares ofcommon stock to an outside consultant, for which $4,000 consulting expense wasrecorded.  Finally in 2003 the Companyaccepted the surrender of 30,000 shares of common stock, with a value of$94,000, from a former executive as payment for the exercise of an option grantto purchase 200,000 shares of common stock. These 200,000 shares of common stock are included in the total 1,188,000shares of common stock issued for employee stock option exercises in 2003.

 

*PreferredStock Transactions.*  During 2003 the Companyraised approximately $14,611,000 through the sale of 1,575 shares of a newlycreated class of Series B Convertible Preferred Stock (Series Bpreferred stock) with attached warrants to buy 630,000 shares of commonstock.  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, 2005, no dividend hadbeen declared.  There is no mandatorydividend on the Series B preferred stock. Prior to the 2005 financing, each share of Series B preferred stockwas convertible, at any time at the holder’s option, into 2,000 shares ofcommon stock, at a conversion price of $5.00 per share, subject toadjustment.  The Series B preferredstock contains anti-dilution provisions that require the conversion price to beadjusted in the event of stock dividends and combinations, certaindistributions, and certain issuances of additional shares of common stock at apurchase price below the then current conversion price.  Giving effect to the antidilutionadjustment occurring as a result of the 2005 financing, the outstanding sharesof Series B preferred stock have a conversion price of $4.57 per share andare convertible into 3,446,389 shares of common stock.  Uponthe occurrence of a liquidation event (generally defined as a Company-approvedchange in control transaction, such as a merger, share exchange, consolidation,reorganization, sale of substantially all assets, dissolution or liquidation),the holders of Series B preferred stock are entitled to receive a minimumpayment, in cash, securities or other assets, of $10,000 per share.  Holders of Series B preferred stock areentitled to vote, together as one class with the common stock holders (exceptas required by law or the Certificate of Designation for the Series Bpreferred stock), on all matters on which the common stock holders have theright to vote.  Each holder of Series Bpreferred stock is entitled to the number of votes equal to the number ofshares of common stock into which the holder’s shares of Series Bpreferred stock could be converted on the record date for the taking of suchvote.  In connection with the proposed equityfinancing (see Note 11), the holders of Series B preferred stock executed anagreement, subject to closing of the proposed equity financing, to converttheir Series B preferred shares into common stock at an adjusted conversionrate of 6060.6061 shares of common stock for each Series B preferredshare.  Assuming closing of the proposedequity financing, the Series B preferred stock received by the Companyupon such conversion will be retired and cancelled and not reissued.

 

Certain provisions of the Investor Rights Agreement for the Series Bpreferred stock require the Company to pay cash liquidated damages if theregistration statement filed with the SEC to register the shares of commonstock issuable upon conversion of the Series B preferred stock andexercise of the 

 

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warrants is not first declared effective by the SEC on or before March 2,2004 (ninety days after sale of the Series B preferred stock).  The Company filed a registration statementwith respect to the common stock underlying the Series B preferred stockand warrants on December 19, 2003. The Company subsequently was advised that the SEC would, as part of itscorporate compliance monitoring process, conduct a full review of theregistration statement and the Company’s periodic reports.  As a consequence of the SEC review process,the registration statement did not become effective until March 17,2004.  The Company therefore may berequired to pay holders of Series B preferred stock cash liquidateddamages equal to 1.5% of the purchase price of the Series B preferredstock for each 30-day period (pro rated for periods of less than 30 days) forwhich the registration statement was not effective.  The amount of liquidated damages that accruedfor the fifteen-day period after March 2, 2004, is approximately $118,000.

 

Holders of Series 1Convertible Exchangeable Preferred Stock (Series 1 preferred stock) areentitled to receive an annual cash dividend of $2.4375 per share if declared bythe Board, payable semi-annually on June 1 and December 1.  Dividends are cumulative.  Each share of Series 1 preferred stockis convertible into 1.14 shares of common stock, subject to adjustment incertain events.  The Series 1preferred stock is redeemable at the option of the Company at $25.00 pershare.  Holders of Series 1preferred stock have no voting rights, except in limited circumstances.  Dividends of $500,000 were paid in each ofthe years 2005, 2004, and 2003, respectively.

 

*Shareholders’Rights Plan*:The Company has adopted a Shareholders’ Rights Plan intended to protect therights of 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 ofthe Company’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 of Series Bpreferred stock had been converted into shares of common stock at the thencurrent conversion price.  Each Rightentitles the registered holder, other than the acquiring person or group, topurchase from the Company one-hundredth of one share of Series A JuniorParticipating Preferred Stock (Series A preferred stock) at a price of$40, subject to adjustment.  The Rightsexpire 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 votewith the 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 ofthe Right, 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 Shareholders’ Rights Plan expires on April 10, 2006.

 

The Board may, withoutfurther action by the shareholders of the Company, issue preferred stock in oneor more series and fix the rights and preferences thereof, including dividendrights, dividend rates, conversion rates, voting rights, terms of redemption,redemption price or prices, liquidation preferences and the number of sharesconstituting any series or the designations of such series.

 

*StockOptions*:  At December 31, 2005, the Company hadone stock option plan under which options were available for grant: the 2004Incentive Compensation Plan (the 2004 Plan). The 1991 Stock Option Plan for Non-Employee Directors (the DirectorsPlan) was terminated on March 31, 2005 and no further options can begranted under that plan.  The Company’s1994 Stock Option Plan (the 1994 Plan) was terminated on February 17, 2004and no further options can be granted under that plan.

 

The 2004 Plan, as amendedand restated in 2005, authorizes the Board or a committee appointed by theBoard to grant options to purchase a maximum of 5,000,000 shares of commonstock.  The 2004 Plan allows for the issuanceof incentive stock options and nonqualified stock options to employees,officers, directors, agents, consultants, advisors and independent contractorsof the Company, subject to certain restrictions. All option grants expire tenyears from the date of grant, except for certain grants to consultants, whichhave expirations based upon terms of service. Option grants for 

 

57

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employees with at leastone year of service become exercisable in monthly increments over afour-year period from the grant date. Option grants for employees with less than one year of service andemployees receiving promotions become exercisable at a rate of 25% after oneyear from the grant date and then in monthly increments at a rate of 1/48th permonth over the following three years.  Asof December 31, 2005, there were 2,476,557 shares of common stockavailable for grant under the 2004 Plan.

 

No shares are availablefor grant under the Directors Plan since its expiration in March 2005,although options granted under the Directors Plan prior to its expirationcontinue in effect in accordance with their terms.  No shares are available for grant under the1994 Plan since its expiration in February 2004, although options grantedunder the 1994 Plan prior to its expiration continue in effect in accordancewith their terms.

 

In connection with anagreement with a consultant in 2005 for investor relations services, theCompany granted stock options to purchase 10,000 shares of common stock at anexercise price of $1.00.  Twenty fivepercent of the options vested upon grant, while the balance vest 1/36thper month until two years after the grant date. Compensation expense is recorded for the fair value of the grant overthe period the services are provided by the consultant.  Based upon the Black-Scholes option-pricingmodel, the fair value of the options ranged from $0.58 to $0.63 per share usingassumptions of expected volatilities ranging from 117% of 126%, contractualterms of three years, expected dividend rate of zero and risk-free rates ofinterest ranging from 4.2% to 4.4%.  TheCompany recorded compensation expense of approximately $1,000 in 2005.  The fair value of the options with futurevesting dates will not be known until the earlier of the vesting of the optionsor the completion of the services being provided.

 

In connection with anagreement with a consultant in 2004 for strategic planning consulting services,the Company granted stock options to purchase 50,000 shares of common stock atan exercise price of $2.24.  The optionsvested on February 27, 2005. Compensation expense is recorded for the fair value of the grant overthe period the services are provided by the consultant.  Based upon the Black-Scholes option-pricing model,the fair value of the options ranged from $0.35 to $1.67 per share usingassumptions of expected volatilities ranging from 117% to 119%, contractualterms of ten years, expected dividend rate of zero and risk-free rates ofinterest of 3.1% to 4.2%.  The Companyrecorded a credit to compensation expense of approximately $20,000 in 2005 andcompensation expense of approximately $37,000 in 2004.

 

In April 2004, theCompany extended to December 31, 2004 the time to exercise stock options,held by 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.

 

In connection with anagreement 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 with variousagreements with consultants in 2002 for consulting services, the Companygranted stock options to purchase 115,000 shares of common stock at exerciseprices ranging from $2.45 to $3.50 per share. The options vest at various intervals up to three years after the grantdate.  All options had vested as of December 31,2005.  Compensation expense is recordedfor the fair values of the grants over the period the services are provided bythe consultants.  Based upon theBlack-Scholes option-pricing model, fair values of the options ranged from$0.01 to $5.32 per share using assumptions of expected volatilities rangingfrom 85% to 141%, contractual terms of up to ten years, expected dividend rateof zero and risk-free rates of interest ranging from 1.2% to 4.1%.  The Company recorded credits to 

 

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compensation expense of$2,000 and $12,000 in 2005 and 2004, respectively, and compensation expense ofapproximately $167,000 in 2003 related to these grants.

 

In connection with aseverance and consulting agreement with a former officer, the Companyaccelerated the vesting of stock options to acquire 100,000 shares of commonstock in 2001.  The Company recordedcompensation expense of approximately $13,000 in 2003 in connection with theseverance and consulting arrangement.

 

In July 2001, theCompany granted stock options pursuant to an agreement outside the Company’s1994 Plan and the Directors Plan to an officer of the Company to purchase150,000 shares of common stock at an exercise price of $3.35 per share.  In June 2003, the options were modifiedto expire twelve months after termination of service to the Company.  The Company recorded compensation expense of$6,000 related to the modification of these options.

 

In connection with variousagreements with consultants in 2001 for consulting services, the Companygranted stock options to purchase 170,000 shares of common stock at exercise pricesranging from $2.34 to $5.53 per share. The options vested at various intervals up to two years after the grantdate.  All options vested during 2003.  Compensation expense was recorded for thefair values of the grants over the period the services were provided by theconsultants.  Based upon theBlack-Scholes option-pricing model, fair values of the options ranged from$2.57 to $4.86 per share using assumptions of expected volatilities rangingfrom 98% to 146%, contractual terms of up to ten years, expected dividend rateof zero and risk-free rates of interest ranging from 1.7% to 4.7%.  The Company recorded a credit to compensationexpense of approximately $66,000 in 2002 and compensation expense of approximately$81,000 in 2003 related to these grants.

 

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 December 31,2005, totaled approximately $1,473,000.

 

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Information relating tostock option activity is as follows (in thousands, except per share data):

 
| ** **                       | ** ** | **2005**              | ** ** | **2004**                                | ** ** | **2003**              | ** ** |
|----------------------------------|------------|-----------------------|------------|-----------------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **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 |       | 3,528                 |       | $                                       | 3.34       |                  | 4,103      |   | $ | 3.68 |   | 4,495 |   | $ | 4.56 |   |
| Granted                          |       | 1,572                 |       | 1.01                                    |       | 1,396                 |       | 2.38 |   | 2,017 |   | 1.21 |   |
| Exercised                        |       | (94                   | )          | 0.47                                    |       | (818                  | )          | 0.98 |   | (1,188 | ) | 1.65 |   |
| Cancelled                        |       | (682                  | )          | 2.50                                    |       | (1,153                | )          | 5.09 |   | (1,221 | ) | 4.77 |   |
| Outstanding at end of year       |       | 4,324                 |       | $                                       | 2.69       |                  | 3,528      |   | $ | 3.34 |   | 4,103 |   | $ | 3.70 |   |
| Exercisable at end of year       |       | 2,379                 |       | $                                       | 3.74       |                  | 1,843      |   | $ | 4.12 |   | 2,953 |   | $ | 4.02 |   |

 

Information relating tostock options outstanding and exercisable at December 31, 2005, is asfollows (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 -  $0.67               |       | 1,256                   |       | 8.68                                             |       | $ | 0.61 |   | 336 |   | $ | 0.47 |   |
|                         |       |                    |       |                                             |       |   |   |   |   |   |   |
| $0.68 -  $2.15               |       | 922                     |       | 7.75                                             |       | 1.62 |   | 398 |   | 1.52 |   |
|                         |       |                    |       |                                             |       |   |   |   |   |   |   |
| $2.24 -  $2.50               |       | 932                     |       | 8.02                                             |       | 2.48 |   | 464 |   | 2.46 |   |
|                         |       |                    |       |                                             |       |   |   |   |   |   |   |
| $2.57 -  $7.50               |       | 919                     |       | 5.47                                             |       | 4.09 |   | 886 |   | 4.14 |   |
| $8.06 -  $18.25              |       | 295                     |       | 4.72                                             |       | 11.26 |   | 295 |   | 11.26 |   |
|                         |       | 4,324                   |       | 7.39                                             |       | $ | 2.69 |   | 2,379 |   | $ | 3.74 |   |

 

*RestrictedStock*.  The Company has a Restricted Stock Plan (theRestricted Stock Plan) under which restricted stock may be granted or sold toselected employees, officers, agents, consultants, advisors and independentcontractors of the Company.  Under theRestricted Stock Plan, which was adopted in 1991, 400,000 shares are authorizedfor grant, of which 60,250 shares remained available for grant at December 31,2005.  There were 70,000 shares grantedwithout restrictions during 2003, of which 10,000 shares were for consultingservices.  The Company recorded expenserelated to these 10,000 shares of approximately $4,000 in consulting expense in2003.  The remaining 60,000 shares,valued at $33,000, were used to settle bonuses that were accrued at December 31,2002.

 

*Warrants*. In connection with the 2005 financing, the Company issued five-yearwarrants to purchase an aggregate of 1,328,000 shares of common stock at anexercise price of $2.00 per share.  Thewarrants became exercisable beginning on September 3, 2005 and,thereafter, are exercisable at any time during their term.  In payment of placement agent fees for the2005 financing, the Company 

 

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issued five-year warrantsto purchase 199,200 shares of common stock at an exercise price of $2.00 pershare. The warrants contain provisions requiring the adjustment of the exerciseprice and number of shares issuable if the Company sells (other than inconnection with certain permitted transactions, such as strategiccollaborations and acquisitions approved by the Board) shares of common stockat a price lower than the then-current exercise price of the warrants. Theshares of common stock issuable upon exercise of the 2005 financing warrantshave been registered with the SEC.

 

In connection with the2004 financing, the purchasers received five-year warrants to purchase anaggregate of 922,500 shares of common stock, at an exercise price of $7.00 pershare. The warrants became exercisable beginning on February 23, 2004 and,thereafter, are exercisable at any time during their term.  The warrants contain provisions requiring theadjustment of the exercise price and number of shares issuable if the Companysells (other than in connection with certain permitted transactions, such asstrategic collaborations and acquisitions approved by the Board) shares ofcommon stock at a price lower than the then-current exercise price of thewarrants.   The warrants are redeemable at the election ofthe Company at any time after March 24, 2006, if the volume-weightedaverage price of the underlying common stock for each trading day over a periodof 20 consecutive trading days is equal to or greater than $10.50 per share,subject to adjustment. The shares of common stock issuable upon exercise of the2004 financing 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 with thesale of its Series B preferred stock, the purchasers of the Series Bpreferred stock received five-year warrants to purchase anaggregate of 630,000 sharesof common stock, at an exercise price of $6.00 per share.  The warrants become exercisable on June 3,2004.  The warrants are redeemable at theelection of the 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 expectedvolatility of 134%, contractual term of five years, expected dividend rate ofzero and a risk-free rate of interest of 3.5%. The shares of common stock issuable upon conversion of the Series Bpreferred stock and exercise of the warrants have been registered with the SEC.

 

In connection with the agreement to purchase the manufacturing facilityin Denton, TX, the Company on April 19, 2001, issued to InternationalIsotopes Inc. a three-year warrant to purchase up to 800,000 shares of commonstock at a purchase price of $10.00 per share. The warrant was valued at $1.61 per share using an option pricing modelwith assumptions of expected volatility of 125%, contractual term of threeyears, expected dividend rate of zero and a risk-free rate of interest of4.6%.    The warrant expired April 19,2004.

 

The Company also issuedwarrants in connection with its PPD line of credit.  See Note 18.

 

#### **NOTE 12.  Acquisition ofPicoplatin (NX 473)**

#### ** **

In April 2004,the Company acquired from AnorMED, Inc. the worldwide exclusive rights,excluding Japan, to develop, manufacture and commercialize picoplatin (NX 473),a platinum-based anti-cancer agent. Under the terms of the agreement, the Company paid AnorMED a one-timeupfront milestone 

 

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paymentof $1,000,000 in its common stock and $1,000,000 in cash. The agreement also provides for additional milestone payments to AnorMEDof up to $13,000,000, payable in cash or a combination of cash and Companycommon stock.  These milestones includesuccessful completion of a picoplatin Phase II study or initiation of apicoplatin Phase III study, submission to the FDA of an NDA for picoplatin,regulatory approval from the FDA of picoplatin and the attainment of certainlevels of annual net sales of picoplatin. Upon regulatory approval, AnorMED would receive royalty payments of upto 15% on product sales.

 

LicensedProducts consists of the picoplatin amortizable intangible with a gross amountof $2,000,000 and accumulated amortization of $292,000 at December 31,2005.  Licensed Products is amortized ona straight-line basis over 12 years.  Theestimated annual amortization expense for Licensed Products is approximately$167,000 for each of the years 2006 through 2010.

 

# **NOTE 13.**  Asset Retirement Obligation

# ** **

The Company recorded a $190,000cumulative effect of change in accounting principle during the first quarter of2003 as a result of the Company’s adoption of SFAS 143, Accounting for AssetRetirement Obligations.  Under SFAS 143,the Company recorded an asset and liability in the amount of $364,000 relatedto the estimated fair value of future decommissioning costs associated with theDenton radiopharmaceutical manufacturing facility.  This estimate was depreciated using a sevenyear estimated useful life for the asset and the asset retirement obligationwas accreted using the thirty year period that represents the expected timethat will elapse prior to the settlement of the obligation.  The asset and liability were depreciated andaccreted, respectively, until December 2003, when the Company sold thereal estate and equipment associated with the Denton radiopharmaceuticalmanufacturing facility for which the fair value of future decommissioning costswas estimated.  The sale of these assetseliminated the future asset retirement obligation as recorded under SFAS 143 asof December 31, 2003.  Accretion ofthe asset retirement obligation totaled $62,000 and depreciation expense forthe asset retirement asset totaled $48,000 for the year ended December 31,2003.

 

#### **NOTE 14.  Revenues**

#### ** **

Revenue in 2005 was$15,000, which consisted primarily of royalty payments received in connectionwith licensed intellectual property.

 

Revenue in 2004 was$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 theassignment and license to Boston Scientific Corporation of certain intellectualproperty and revenue from a facilities lease agreement.  The sale to Boston Scientific Corporationincluded no substantive continuing involvement by the Company and has thereforebeen fully recognized as revenue in 2003.

 

**NOTE 15. Federal Income Taxes**

 

Temporary differences andcarryforwards giving rise to deferred tax assets were as follows (inthousands):

 

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| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Net operating loss carryforwards                   |       | $                     | 47,008     |   | $ | 42,231 |   |
| Research and experimentation credit  carryforwards |       | 8,883                 |       | 8,431 |   |
| Capitalized research and development               |       | 11,709                |       | 11,957 |   |
| Property and equipment                             |       | 1,694                 |       | 744 |   |
| Other                                              |       | 718                   |       | 1,398 |   |
| Deferred tax assets                                |       | 70,012                |       | 64,761 |   |
| Deferred tax asset valuation allowance             |       | $                     | (70,012    | ) | $ | (64,761 | ) |
| 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 itsdeferred tax assets. Accordingly, no tax benefits have been recorded in theaccompanying statements of operations. The valuation allowance increased by$5,251,000, $13,123,000 and $2,552,000 in 2005, 2004 and 2003, respectively.

 

The Company has netoperating loss carryforwards of approximately $138,000,000, which expire from2006 through 2025.  Research andexperimentation credits expire from 2006 to 2025.  As a result of changes in ownership, theutilization of the Company’s net operating loss carryforwards may be limited.

 

Approximately $21,000,000of the Company’s net operating loss carryforwards at December 31, 2005,result from deductions associated with the exercise of non-qualified employeestock options, the realization of which would result in a credit toshareholders’ equity.

 

#### **NOTE 16.  Related PartyTransactions**

#### ** **

BayCity Capital LLC (BCC) is a financial advisor to and indirectly controls BayCity Capital Fund IV, LP and Bay City Capital IV Co-Investment Fund, LP (theBay City Funds), both of which are investors in the bridge loan and theproposed equity financing.  Two of theCompany’s directors, Dr. Fred Craves and Dr. Carl Goldfischer, aremanaging directors of BCC and possess capital and carried interests in the BayCity Funds.  As lenders in the February2006 bridge financing, the Bay City Funds received bridge notes in theaggregate principal amount of $798,000 and a five-year bridge warrant topurchase an aggregate of 570,000 shares of Company common stock at an exerciseprice of $0.77 per share.

 

The Company and BCCentered into an agreement whereby BCC acted as the Company’s advisor for thepurpose of identifying opportunities to enter into strategic alliances. TheCompany paid a retainer fee of $25,000 and $80,000 in cash for each calendarquarter of 2003 except for the quarter ended March 31, 2003, for which theretainer fee was $26,667.  Retainer feepayments under this agreement totaled $21,667 for 2003.  The 2003 payments included the quarterlypayments referenced above less $80,000 paid in 2002 relating to 2003services  The agreement also included apercentage of consideration, ranging from one to five percent, depending on theultimate amount of consideration raised. BCC agreed to exclude the Boston Scientific Corporation sale andassignment of intellectual property from its agreement with the Company, and,therefore, received no commission or other compensation related to the BostonScientific transaction.  The agreementexpired on December 31, 2003, and the Company elected not to renew it.

 

#### **NOTE 17.  401(K) Plan**

#### ** **

The Company sponsors a401(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 $12,000, $11,000, and $11,000 for the years ended December 31,2005, 2004, and 2003, respectively.  TheCompany has no other post employment or post retirement benefit plans.

 

63

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#### **NOTE 18.  Line of Credit**

#### ** **

In 2000, the Companyestablished a line of credit with Pharmaceutical Product Development, Inc.(PPD) of up to $5,000,000 to assist in funding the Company’s pivotal Phase IIItrial of its STR product candidate.  Theline expired in February 2004.  Nofunds were drawn against the line through the date of termination.

 

In connection with theline of credit, the Company issued PPD a warrant to purchase 75,000 shares ofCompany 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.

 

#### **NOTE 19.  UnauditedQuarterly Data**

#### ** **

The following tablepresents summarized unaudited quarterly financial data (in thousands, exceptper share data):

 
| ** **                           | ** ** | **First   Quarter** | ** ** | **Second   Quarter** | ** ** | **Third   Quarter** | ** ** | **Fourth   Quarter** | ** ** |
|--------------------------------------|------------|---------------------|------------|----------------------|------------|---------------------|------------|----------------------|------------|
| **2005**                             |       |                |       |                 |       |                |       |                 |       |
| Revenues                             |       | $                   | —     |                 | $          | 2                   |       | $                    | 2          |   | $ | 11 |   |
| Operating expenses                   |       | 5,106               |       | 8,887                |       | 3,094               |       | 3,988                |       |
| Net loss                             |       | (5,076              | )          | (8,853               | )          | (3,078              | )          | (3,990               | )          |
| Net loss applicable to common shares |       | (5,201              | )          | (8,978               | )          | (3,203              | )          | (4,115               | )          |
| Net loss per common share:           |       |                |       |                 |       |                |       |                 |       |
| Basic                                |       | (0.16               | )          | (0.26                | )          | (0.09               | )          | (0.12                | )          |
| Diluted                              |       | (0.16               | )          | (0.26                | )          | (0.09               | )          | (0.12                | )          |
| **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                | )          |

 

Note: Net loss per commonshare – basic and diluted may not add to net loss per common share for the yeardue to rounding.

 

64

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***Item9.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE***

 

Not Applicable.

 

***Item9A.  CONTROLS AND PROCEDURES***

 

Underthe supervision and with the participation of the Company’s management,including the Company’s Chairman and Chief Executive Officer and the ChiefFinancial Officer, the Company has evaluated the effectiveness and design ofits disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e)) as of the end of the period covered by this report, and, based ontheir evaluation, the Chairman and Chief Executive Officer and the ChiefFinancial Officer have concluded that these disclosure controls and procedures wereeffective as of December 31, 2005, 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.

 

Therewere no changes to the Company’s internal control over financial reporting thatoccurred during the fourth quarter of 2005 that have materially affected, orare reasonably likely to affect, the Company’s internal control over financialreporting.

 

On December 21,2005, the SEC issued Release No 33-8644, “Revisions to Accelerated FilerDefinition and Accelerated Deadlines for Filing Periodic Reports” (the SECRelease).  Included in the SEC Releasewas an amendment to revise the definition of the term “accelerated filer” topermit an accelerated filer that has an aggregate worldwide market value ofvoting and non-voting common equity held by non-affiliates of less than $50million to exit accelerated filer status at the end of the fiscal year in whichthe company’s equity falls below $50 million as of the last business day of itssecond fiscal quarter and to file its annual report for that year andsubsequent periodic reports on a non-accelerated basis.  Accelerated filer status affects an issuer’s deadlinesfor filing its periodic reports with the SEC and complying with the internalcontrol over financial reporting requirements of Section 404 of theSarbanes-Oxley Act of 2002, including the attestation report of a registeredpublic accounting firm.  Anon-accelerated filer must begin to comply with the Section 404 internalcontrol over financial reporting requirements for its first fiscal year on orafter July 15, 2007.

 

Theaggregate worldwide market value of the Company’s equity held by non-affiliatesas of June 30, 2005, the last business day of the Company’s second fiscalquarter, was less than $50 million.  As aresult, as of December 31, 2005, the Company exited accelerated filerstatus.

 

Priorto the SEC Release, the Company was classified as an “accelerated filer” andwas required to comply with the internal control over financial reportingrequirements of Section 404, including the attestation report of aregistered public accounting firm.  Inlight of the SEC Release, the Company, as a non-accelerated filer as of December 31,2005, is not required to comply with Section 404 internal control overfinancial reporting requirements as of December 31, 2005.

 

***Item9B.  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 2006 AnnualMeeting of Shareholders to be held on June 16, 2006, filed with theSecurities and Exchange Commission, or the Commission, pursuant to Section 14(a) ofthe Securities Exchange Act of 1934, or the Exchange Act, as amended.

 

65

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

 

 
| **Name**                 | ** ** | **Age** | ** ** | **Position with the Company**                                              |
|--------------------------|------------|---------|------------|----------------------------------------------------------------------------|
| Gerald McMahon, PhD |       | 51      |       | Chairman, President and Chief Executive  Officer                           |
| Susan D. Berland         |       | 51      |       | Chief Financial Officer                                                    |
| David  A. Karlin, M.D.   |       | 62      |       | Senior Vice President, Clinical  Development & Regulatory Affairs |
| Anna L. Wight, JD        |       | 51      |       | Vice President, Legal and Secretary                                        |

 

#### **Business Experience**

#### ** **

*GeraldMcMahon, PhD,*was appointed Chief Executive Officer of the Company in May 2004and Chairman of the Board of Directors in June 2004.  Dr. McMahon was appointed President ofthe Company on June 15, 2005. Previously, he was President of SUGEN, Inc., a biopharmaceuticalcompany focused on the discovery and development of novel targetedsmall-molecule drugs. At SUGEN, Dr. McMahon played a key role in thediscovery and development of several innovative cancer products, including SU-11248,a multi-targeted protein kinase inhibitor for the treatment of advancedcancers, now in Phase III trials with Pfizer Inc. SUGEN was acquired byPharmacia Corp. in 1999, which subsequently was acquired by Pfizer in 2003.Prior to his role at SUGEN, which he joined in 1993, Dr. McMahon heldseveral research and development management positions at Sandoz Pharmaceuticals(now Novartis), where his responsibilities included the establishment ofexternal collaborations and the development of corporate alliances within theUS and Europe. Dr. McMahon has contributed to more than 100 scientificpublications and was a Staff Scientist and Principal Investigator at theMassachusetts Institute of Technology and Tufts University School of Medicineearly in his career. He holds a BS in Biology and a PhD in Biochemistry fromRensselaer Polytechnic Institute.

 

*Susan D.**Berland* joined the Company in October 2004as Chief Financial Officer. Previously, Ms. Berland was Chief FinancialOfficer at DNA Sciences, Inc. from 2000 to 2003, where she was responsiblefor the completion of several strategic financings. Ms. Berland joined DNASciences after four years at Monsanto Company, leading up to the merger ofMonsanto with Pharmacia Corp. and Upjohn Company. While at Monsanto, she was akey member of the management team with oversight of financial planning andnumerous merger and acquisition transactions. Most recently, Ms. Berlandhas served as an independent consultant for biotechnology companies. Ms. Berlandhas an MBA and a BA in Business Administration from the University of Wisconsin- Milwaukee.

 

*David A. Karlin, M.D.,* joined the Company as Senior Vice President of ClinicalDevelopment and Regulatory Affairs in July 2005. Prior thereto, Dr. Karlinserved as Vice President of Clinical Research at Cellegy Pharmaceuticals, Inc.from 2002 to 2005.  Dr. Karlin’sexperience in the biotech and pharmaceutical industry also includes positionsas Vice President of Clinical Development for Genteric, Inc., a privatelyheld company specializing in gene therapy during 2002, and Senior MedicalDirector at Matric Pharmaceuticals, Inc., an oncology therapeuticsdevelopment company (1991 to 2001). Dr. Karlin has also served as VicePresident for Clinical Research and Medical Director at SciClonePharmaceuticals, Inc. from 1995 to 1999 and held various positions atSyntex Corporation, including Director of Medical Research from 1986 to 1995.Before joining the pharmaceutical industry, Dr. Karlin was an associateprofessor at Temple University School of Medicine and an assistant professor atthe University of Texas M.D. Anderson Hospital and Tumor Institute. He receivedhis M.D. from the University of Chicago and completed his residency in InternalMedicine at the University of Michigan and a fellowship in Gastroenterology andGastrointestinal Oncology at the University of Chicago. He holds a B.S. inBiology from the University of Illinois.

 

*Anna Lewak Wight, JD,*was promoted to VicePresident, Legal and Secretary in September 2001, having served asDirector of Intellectual Property since joining NeoRx in 1994.  She previously was a partner in the law firmof Morrison & Foerster, managing their Seattle intellectual propertypractice.  Ms. Wight also was apartner in the intellectual property law firm of Harness, Dickey and Pierce inMichigan, where she established and chaired the Biotechnology and Medical ArtsGroup.  Ms. Wight received a JD fromWayne State University Law School and an MS from the Genetics Program atMichigan State University.

 

66

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(c) *Compliance with Section 16(a) of the Exchange Act*.  The information required by this item isincorporated herein by reference to the section captioned “Section 16(a) BeneficialOwnership Compliance” in the Company’s definitive Proxy Statement for the 2006Annual Meeting of Shareholders to be held June 16, 2006, filed with theCommission pursuant to Section 14(a) of the  Exchange Act.

 

(d) *Code of Ethics.*  Theinformation required by this item is incorporated herein by reference to the section captioned“Codes of Ethics and Code of Conduct” in the Company’s definitive ProxyStatement for the 2006 Annual Meeting of Shareholders to be held June 16,2006, filed with the Commission pursuant to Section 14 (a) ofthe  Exchange Act.

 

***Item 11. EXECUTIVE COMPENSATION***

*** ***

The information requiredby this item is incorporated herein by reference to the section captioned “ExecutiveCompensation” in the Company’s definitive Proxy Statement for the 2006 AnnualMeeting of Shareholders to be held June 16, 2006, filed with theCommission pursuant to Section 14(a) of the Exchange Act.

 

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

*** ***

The information requiredby this item is incorporated herein by reference to the sections captioned “SecurityOwnership of Certain Beneficial Owners and Management” and “Equity CompensationPlan Information” in the Company’s definitive Proxy Statement for the 2006Annual Meeting of Shareholders to be held June 16, 2006, filed with theCommission pursuant to Section 14(a) of the Exchange Act.

 

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

*** ***

The information requiredby this item is incorporated herein by reference to the section captioned “CertainRelationships and Related Transactions with Management” in the Company’sdefinitive Proxy Statement for the 2006 Annual Meeting of Shareholders to beheld June 16, 2006, filed with the Commission pursuant to Section 14(a) ofthe Exchange Act.

 

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

*** ***

The information required by this item is incorporated herein byreference to the section captioned “Principal Accounting Fees and Services” in the Company’sdefinitive Proxy Statement for the 2006 Annual Meeting of Shareholders to beheld June 16, 2006, filed with the Commission pursuant to Section 14(a) ofthe Exchange Act.

 

67

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**PART IV**

 

***Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES***

*** ***

(a)          (1) Financial Statements — SeeIndex to Financial Statements.

 

(2) FinancialStatement Schedules — Not applicable.

 

(3) Exhibits— See Exhibit Index filed herewith.

 

(b) Exhibits– See Exhibit Index filed herewith.

 

68

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|                | NEORX CORPORATION        |
|---------------------|--------------------------|
|                | (Registrant)             |
|                |                     |
|                |                     |
|                | /s/ SUSAN  D. BERLAND    |   |
|                | Susan D.  Berland        |   |
|                | Chief  Financial Officer |   |
|                |                     |
| Date: March 1, 2006 |                     |

 

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,  President and Chief   Executive Officer | March 1, 2006 |
|--------------------------|--------|----------------------------------------------------|---------------|
| Gerald  McMahon          |   |                                               |
|                     |   |                                               |          |
| /s/ FRED  B. CRAVES      |   | Director                                           | March 1, 2006 |
| Fred B.  Craves          |   |                                               |          |
|                     |   |                                               |          |
| /s/ E.  ROLLAND DICKSON  |   | Director                                           | March 1, 2006 |
| E. Rolland  Dickson      |   |                                               |          |
|                     |   |                                               |          |
| /s/ CARL  S. GOLDFISCHER |   | Director                                           | March 1, 2006 |
| Carl S.  Goldfischer     |   |                                               |          |
|                     |   |                                               |          |
| /s/ ALAN  A. STEIGROD    |   | Director                                           | March 1, 2006 |
| Alan A.  Steigrod        |   |                                               |          |
|                     |   |                                               |          |
| /s/ ROBERT  M. LITTAUER  |   | Director                                           | March 1, 2006 |
| Robert M.  Littauer      |   |                                               |          |
|                     |   |                                               |          |
| /s/ DAVID  R. STEVENS    |   | Director                                           | March 1, 2006 |
| David R.  Stevens        |   |                                               |          |
|                     |   |                                               |          |
| /s/ ALAN  B. GLASSBERG   |   | Director                                           | March 1, 2006 |
| Alan B.  Glassberg       |   |                                               |          |

 

69

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**EXHIBIT INDEX**

** **
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                        | ** ** | ** ** |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 3.1         |       | Amended and Restated Articles of  Incorporation, as amended June 15, 2005                                                                                                                                         |       | (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        |       | Stock Option Grant Program for Nonemployee  Directors under the NeoRx 2004 Incentive Compensation Plan, as amended                                                                                                     |       | (B)        |
| 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       |       | Stock Option Grant Program for  Nonemployee Directors under the NeoRx Corporation 1994 Restated Stock Option  Plan (‡)                                                                                            |       | (M)        |
| 10.12       |       | Facilities Lease, dated  February 15, 2002, between NeoRx Corporation and Selig Real Estate  Holdings Six                                                                                                         |       | (A)        |
| 10.13       |       | Lease Termination/Continuation Agreement  dated October 8, 2002, between NeoRx Corporation and Dina Corporation                                                                                                   |       | (N)        |
| 10.14       |       | Key Executive Severance Agreement dated  as of May 13, 2003, between the Company and Karen Auditore-Hargreaves  (‡)                                                                                          |       | (C)        |
| 10.15       |       | Amendment No. 1 dated as of  March 30, 2005 to Key Executive Severance Agreement dated as of  May 13, 2003, between the Company and Karen Auditore-Hargreaves (‡)                                  |       | (L)        |
| 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       |       | Amendment No. 1 dated as of  March 30, 2005 to Key Executive Severance Agreement dated as of  February 28, 2003, between the Company and Linda Findlay (‡)                                         |       | (L)        |
| 10.19       |       | Change of Control Agreement dated as of  February 28, 2003, between the Company and Linda Findlay (‡)                                                                                                        |       | (C)        |
| 10.20       |       | Key Executive Severance Agreement dated  as of February 28, 2003, between the Company and Anna Wight (‡)                                                                                                     |       | (C)        |
| 10.21       |       | Amendment No. 1 dated as of  March 30, 2005 to Key Executive Severance Agreement dated as of  February 28, 2003, between the Company and Anna Wight (‡)                                            |       | (L)        |
| 10.22       |       | Change of Control Agreement dated as of  February 28, 2003, between the Company and Anna Wight (‡)                                                                                                           |       | (C)        |
| 10.23       |       | Key Executive Severance Agreement dated  as of June 23, 2005, between the Company and David A. Karlin (‡)                                                                                                    |       | (P)        |
| 10.24       |       | Change of Control Agreement dated as of  June 23, 2005, between the Company and David A. Karlin (‡)                                                                                                          |       | (P)        |
| 10.25       |       | Amended and Restated 2004 Incentive  Compensation Plan (‡)                                                                                                                                                        |       | (G)        |
| 10.26       |       | Manufacturing and Supply Agreement dated  as of May 4, 2004, between Hyaluron, Inc. and the Company. Certain  portions of the agreement have been omitted pursuant to a request for  confidential treatment. |       | (T)        |

 

70

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| 10.27 |   | Employment Letter dated as of  April 26, 2004, between the Company and Gerald McMahon (‡)                                                                                                                               |   | (L) |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----|
| 10.28 |   | Key Executive Severance Agreement dated  as of May 11, 2004, between the Company and Gerald McMahon (‡)                                                                                                                 |   | (R) |
| 10.29 |   | Change of Control Agreement dated as of  May 11, 2004, between the Company and Gerald McMahon (‡)                                                                                                                       |   | (R) |
| 10.30 |   | Key Executive Severance Agreement dated  as of October 25, 2004, between the Company and Susan D. Berland (‡)                                                                                                           |   | (S) |
| 10.31 |   | Amendment No. 1 dated as of  March 30, 2005 to Key Executive Severance Agreement dated as of  October 25, 3004, between the Company and Susan D. Berland (‡)                                                  |   | (L) |
| 10.32 |   | Change of Control Agreement dated as of  October 25, 2004, between the Company and Susan D. Berland (‡)                                                                                                                 |   | (S) |
| 10.33 |   | Form of Non-Qualified Stock Option  Agreement under 2004 Incentive Compensation Plan (‡)                                                                                                                                |   | (O) |
| 10.34 |   | Form of Incentive Stock Option  Agreement under 2004 Incentive Compensation Plan (‡)                                                                                                                               |   | (O) |
| 10.35 |   | Consulting Agreement between the Company  and Alan B. Glassberg, M.D. (‡)                                                                                                                                                    |   | (T) |
| 10.36 |   | Letter Agreement dated October 14,  2005, between the Company and Texas State Bank                                                                                                                                           |   | (U) |
| 10.37 |   | Letter Agreement dated January 30,  2006, between the Company and Texas State Bank                                                                                                                                           |   | (V) |
| 10.38 |   | Research Funding and Option Agreement  dated August 4, 2005, between the Company and The Scripps Research  Institute. Certain portions of the agreement have been omitted pursuant to a  request for confidential treatment. |   | (U) |
| 10.39 |   | Securities Purchase Agreement dated as  of February 1, 2006, by and among the Company and the Purchasers named  therein                                                                                                      |   | (V) |
| 10.40 |   | Note and Warrant Purchase Agreement  dated as of February 1, 2006, by and among the Company and the  Purchasers named therein                                                                                                |   | (V) |
| 10.41 |   | Security Agreement dated as of  February 1, 2006, by and among the Company and the Secured Parties named  therein                                                                                                            |   | (V) |
| 10.42 |   | Irrevocable Consent of Holders of  Series B Convertible Preferred Stock dated as of February 1, 2006                                                                                                                    |   | (V) |
| 23.1  |   | Consent of KPMG LLP                                                                                                                                                                                                               |   | (W) |
| 31.1  |   | Rule 13a-14(a)/15d-14(a) Certification  of Chairman and Chief Executive Officer                                                                                                                                         |   | (W) |
| 31.2  |   | Rule 13a-14(a)/15d-14(a) Certification  of Chief Financial Officer                                                                                                                                                      |   | (W) |
| 32.1  |   | Section 1350 Certification of  Chairman and Chief Executive Officer                                                                                                                                                          |   | (W) |
| 32.2  |   | Section 1350 Certification of Chief  Financial Officer                                                                                                                                                                       |   | (W) |

 

----

| (‡) |   | 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 June 16, 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.                                              |

 

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| (G)    |   | Incorporated by reference to  Exhibit A to the Company’s definitive proxy statement on  Schedule 14A filed April 29, 2005.           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                     |
| (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, 2005, 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. |
|   |   |                                                                                                                                                     |
| (P)    |   | Filed as an exhibit to the Company’s  Current Report on Form 8-K filed on June 29, 2005, 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  Current Report on Form 8-K filed October 19, 2004, and incorporated  herein by reference.           |
|   |   |                                                                                                                                                     |
| (T)    |   | Filed as an exhibit to the Company’s  Form 10-Q for the quarterly period ended June 30, 2005, and  incorporated herein by reference.      |
|   |   |                                                                                                                                                     |
| (U)    |   | Filed as an exhibit to the Company’s  Form 10-Q for the quarterly period ended September 30, 2005, and  incorporated herein by reference. |
|   |   |                                                                                                                                                     |
| (V)    |   | Filed as an exhibit to the Company’s  Form 8-K filed on February 3, 2006 and incorporated herein by  reference.                           |
|   |   |                                                                                                                                                     |
| (W)    |   | Filed herewith.                                                                                                                                          |

 

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