**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 

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| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|-----------------------------------------------------------------------------------------------|

 

**For thequarterly period ended September 30, 2004**

 

**CommissionFile No. 0-16614**

 

**NEORX CORPORATION**

(Exact name of Registrant asspecified in its charter)

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

 

**300 Elliott Avenue West, Suite500, Seattle, Washington 98119-4114**

(Address of principalexecutive offices)

 

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

 

Indicate by check mark whether the Registrant:(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

 

Yes  ý    No  o

 

Indicate by check mark whether the Registrant isan accelerated filer (as defined in Rule 12b-2 of the Exchange Act.

 

Yes  ý    No  o

 

As of November 1, 2004, 30,860,253 shares of theRegistrant’s common stock, $.02 par value per share, were outstanding.

 

 

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**TABLE OFCONTENTS**

 

**QUARTERLYREPORT ON FORM 10-Q**

**FOR THEQUARTER ENDED SEPTEMBER 30, 2004**

 
| **PART I**  | **FINANCIAL INFORMATION**                                                                                        | ** ** |
|-------------|------------------------------------------------------------------------------------------------------------------|------------|
| ** **  | ** **                                                                                                       | ** ** |
| Item 1.     | Financial Statements (Unaudited):                                                                                |       |
|        |                                                                                                             |       |
|        | Condensed Consolidated Balance Sheets as of  September 30, 2004 and December 31, 2003                            |       |
|        |                                                                                                             |       |
|        | Condensed Consolidated Statements of  Operations for the Three and Nine months ended September 30, 2004 and 2003 |       |
|        |                                                                                                             |       |
|        | Condensed Consolidated Statements of Cash  Flows for the Nine Months Ended September 30, 2004 and 2003           |       |
|        |                                                                                                             |       |
|        | Notes to Condensed Consolidated Financial  Statements                                                            |       |
|        |                                                                                                             |       |
| Item 2.     | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                      |       |
|        |                                                                                                             |       |
| Item  3.    | Quantitative  and Qualitative Disclosures About Market Risk                                                      |       |
|        |                                                                                                             |       |
| Item 4.     | Controls and  Procedures                                                                                         |       |
|        |                                                                                                             |       |
| **PART II** | **OTHER INFORMATION**                                                                                            | ** ** |
| ** **  | ** **                                                                                                       | ** ** |
| Item 6.     | Exhibits                                                                                                         |       |
|        |                                                                                                             |       |
|        | Signatures                                                                                                       |       |
|        |                                                                                                             |       |
|        | Exhibit Index                                                                                                    |       |

** **

**2**

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** **

**PARTI.  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**NEORXCORPORATION AND SUBSIDIARY**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(in thousands, except share data)

 

 
| ** **                                                                                                                                                                              | ** ** | **(unaudited)****September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------|------------|
| **ASSETS**                                                                                                                                                                              |       |                                  |       |                  |       |
| **Current  assets:**                                                                                                                                                                    |       |                                  |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                              |       | $                                     | 20,599     |                  | $          | 15,166 |   |
| Investment  securities                                                                                                                                                                  |       | 1,497                                 |       | 12,335                |       |
| Prepaid  expenses and other current assets                                                                                                                                              |       | 436                                   |       | 652                   |       |
| Total  current assets                                                                                                                                                                   |       | 22,532                                |       | 28,153                |       |
|                                                                                                                                                                                    |       |                                  |       |                  |       |
| Facilities  and equipment                                                                                                                                                               |       | 9,404                                 |       | 9,103                 |       |
| Less  accumulated depreciation                                                                                                                                                          |       | 2,141                                 |       | 1,632                 |       |
| Facilities  and equipment, net                                                                                                                                                          |       | 7,263                                 |       | 7,471                 |       |
| Other assets                                                                                                                                                                            |       | 67                                    |       | 67                    |       |
| Licensed  products, less accumulated amortization of $83                                                                                                                                |       | 1,917                                 |       | —                |       |
|                                                                                                                                                                                    |       |                                  |       |                  |       |
| **Total**** assets**                                                                                                                                                               |       | $                                     | 31,779     |                  | $          | 35,691 |   |
|                                                                                                                                                                                    |       |                                  |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                           |       |                                  |       |                  |       |
|                                                                                                                                                                                    |       |                                  |       |                  |       |
| **Current  liabilities:**                                                                                                                                                               |       |                                  |       |                  |       |
| Accounts  payable                                                                                                                                                                       |       | $                                     | 371        |                  | $          | 409 |   |
| Accrued  liabilities                                                                                                                                                                    |       | 1,287                                 |       | 1,295                 |       |
| Current  portion of note payable                                                                                                                                                        |       | 267                                   |       | 385                   |       |
| Total  current liabilities                                                                                                                                                              |       | 1,925                                 |       | 2,089                 |       |
| ** **                                                                                                                                                                              |       |                                  |       |                  |       |
| **Long-term  liabilities:**                                                                                                                                                             |       |                                  |       |                  |       |
| Note  payable, net of current portion                                                                                                                                                   |       | 4,004                                 |       | 4,112                 |       |
|                                                                                                                                                                                    |       |                                  |       |                  |       |
| **Shareholders’  equity:**                                                                                                                                                         |       |                                  |       |                  |       |
| Preferred stock, $.02 par value, 3,000,000 shares  authorized:                                                                                                                          |       |                                  |       |                  |       |
| Convertible preferred stock, Series 1, 205,340 shares issued and  outstanding at September 30, 2004 and December 31, 2003 (entitled in  liquidation to $5,300 and $5,175, respectively) |       | 4                                     |       | 4                     |       |
| Convertible preferred stock, Series B, 1,575 shares issued and  outstanding at September 30, 2004 and December 31, 2003 (entitled in  liquidation to $15,750)                           |       | —                                |       | —                |       |
| Common stock, $.02 par value, 60,000,000 shares authorized,  30,485,796 and 28,002,945 shares issued and outstanding at September 30, 2004 and December 31,  2003, respectively         |       | 610                                   |       | 560                   |       |
| Additional  paid-in capital                                                                                                                                                             |       | 254,139                               |       | 243,365               |       |
| Accumulated  deficit, including other comprehensive loss of $3 and $7   at September 30, 2004 and December 31, 2003, respectively                                                       |       | (228,903                              | )          | (214,439              | )          |
| Total  shareholders’ equity                                                                                                                                                        |       | 25,850                                |       | 29,490                |       |
| **Total liabilities and****shareholders’ equity**                                                                                                                             |       | $                                     | 31,779     |                  | $          | 35,691 |   |

 

See accompanying notes to thecondensed consolidated financial statements.

 

3

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**NEORXCORPORATION AND SUBSIDIARY**

 

**CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(in thousands, except per share data)

(unaudited)

 
| ** **                                                                         | ** ** | **Three Months Ended September  30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| **Revenues**                                                                       |       | $                                     | 5          |                                | $          | 225 |   | $ | 1,013 |   | $ | 10,531 |   |
| **Operating  expenses:**                                                           |       |                                  |       |                                |       |   |   |   |   |
| Research and  development                                                          |       | 3,118                                 |       | 2,037                               |       | 10,009 |   | 7,376 |   |
| General and  administrative                                                        |       | 1,492                                 |       | 1,142                               |       | 5,173 |   | 4,742 |   |
| Total  operating expenses                                                          |       | 4,610                                 |       | 3,179                               |       | 15,182 |   | 12,118 |   |
| Loss from  operations                                                              |       | (4,605                                | )          | (2,954                              | )          | (14,169 | ) | (1,587 | ) |
| **Other  income (expense):**                                                       |       |                                  |       |                                |       |   |   |   |   |
| Loss on sale  of securities                                                        |       | —                                |       | (142                                | )          | — |   | (142 | ) |
| Interest  income                                                                   |       | 83                                    |       | 30                                  |       | 232 |   | 184 |   |
| Interest  expense                                                                  |       | (59                                   | )          | (57                                 | )          | (156 | ) | (177 | ) |
| Total other income (expense)                                                       |       | 24                                    |       | (169                                | )          | 76 |   | (135 | ) |
| Net loss  before cumulative effect of change in accounting principle               |       | (4,581                                | )          | (3,123                              | )          | (14,093 | ) | (1,722 | ) |
| Cumulative  effect of change in accounting principle                               |       | —                                |       | —                              |       | — |   | (190 | ) |
| Net loss                                                                           |       | (4,581                                | )          | (3,123                              | )          | (14,093 | ) | (1,912 | ) |
| Preferred  stock dividends                                                         |       | (125                                  | )          | (125                                | )          | (375 | ) | (375 | ) |
| Net loss  applicable to common shares                                              |       | $                                     | (4,706     | )                                   | $          | (3,248 | ) | $ | (14,468 | ) | $ | (2,287 | ) |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| Loss per  share applicable to common shares:                                       |       |                                  |       |                                |       |   |   |   |   |
| Basic and  diluted loss before cumulative effect of change in accounting principle |       | $                                     | (0.15      | )                                   | $          | (0.12 | ) | $ | (0.48 | ) | $ | (0.07 | ) |
| Cumulative  effect of change in accounting principle                               |       | —                                |       | —                              |       | — |   | (0.01 | ) |
| Basic and  diluted loss applicable to common shares                                |       | $                                     | (0.15      | )                                   | $          | (0.12 | ) | $ | (0.48 | ) | $ | (0.08 | ) |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| Shares used  in calculation of loss per share:                                     |       |                                  |       |                                |       |   |   |   |   |
| Basic and  diluted                                                                 |       | 30,419                                |       | 27,355                              |       | 29,901 |   | 27,062 |   |

 

See accompanying notes to the condensed consolidated financialstatements.

 

4

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**NEORX CORPORATION AND SUBSIDIARY**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
| ** **                                                                                 | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                 | ** ** | **2004**                            | ** ** | **2003** | ** ** |
|                                                                                       |       |                                |       |   |   |
| **Cash  flows from operating activities:**                                                 |       |                                |       |   |   |
| Net loss                                                                                   |       | $                                   | (14,093    | ) | $ | (1,912 | ) |
| Adjustments  to reconcile net loss to net cash (used in) provided by operating activities: |       |                                |       |   |   |
| Depreciation  and amortization                                                             |       | 592                                 |       | 607 |   |
| Loss on disposal  of equipment                                                             |       | —                              |       | 240 |   |
| Cumulative  effect of change in accounting principle                                       |       | —                              |       | 190 |   |
| Accretion of  asset retirement obligation liability                                        |       | —                              |       | 50 |   |
| Gain on sale  of securities                                                                |       | —                              |       | 142 |   |
| Common stock  issued for services                                                          |       | —                              |       | 4 |   |
| Stock  options and warrants issued for services                                            |       | (6                                  | )          | 276 |   |
| Stock-based  employee compensation                                                         |       | 340                                 |       | 590 |   |
| Change in  operating assets and liabilities:                                               |       |                                |       |   |   |
| Prepaid  expenses and other assets                                                         |       | 216                                 |       | (60 | ) |
| Accounts  payable                                                                          |       | (38                                 | )          | (371 | ) |
| Accrued  liabilities                                                                       |       | (133                                | )          | (909 | ) |
| Net cash  used in operating activities                                                     |       | (13,122                             | )          | (1,153 | ) |
|                                                                                       |       |                                |       |   |   |
| **Cash  flows from investing activities:**                                                 |       |                                |       |   |   |
| Proceeds  from sales and maturities of investment securities                               |       | 10,874                              |       | 19,211 |   |
| Purchases of  investment securities                                                        |       | (32                                 | )          | (23,049 | ) |
| Facilities  and equipment purchases                                                        |       | (301                                | )          | (51 | ) |
| Licensed  products                                                                         |       | (1,000                              | )          | — |   |
| Proceeds  from sales of equipment                                                          |       | —                              |       | 188 |   |
| Net cash  provided by (used in) investing activities                                       |       | 9,541                               |       | (3,701 | ) |
|                                                                                       |       |                                |       |   |   |
| **Cash  flows from financing activities:**                                                 |       |                                |       |   |   |
| Proceeds  from stock options and warrants exercised                                        |       | 448                                 |       | 1,196 |   |
| Receipt of  note receivable principal                                                      |       | —                              |       | 68 |   |
| Repayment of  note payable principal                                                       |       | (226                                | )          | (284 | ) |
| Repayment of  capital lease obligation                                                     |       | —                              |       | (50 | ) |
| Preferred  stock dividends                                                                 |       | (250                                | )          | (250 | ) |
| Proceeds  from issuance of common stock and warrants                                       |       | 9,042                               |       | — |   |
| Net cash  provided by financing activities                                                 |       | 9,014                               |       | 680 |   |
|                                                                                       |       |                                |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |       | 5,433                               |       | (4,174 | ) |
|                                                                                       |       |                                |       |   |   |
| **Cash and cash equivalents:**                                                             |       |                                |       |   |   |
| Beginning of period                                                                        |       | 15,166                              |       | 6,564 |   |
| End of period                                                                              |       | $                                   | 20,599     |   | $ | 2,390 |   |
|                                                                                       |       |                                |       |   |   |
| **Supplemental  disclosure of non-cash financing activity:**                               |       |                                |       |   |   |
| Issuance of common stock to settle accrued bonuses                                         |       | $                                   | —     |   | $ | 33 |   |
| Purchase of  Licensed Products with common stock                                           |       | $                                   | 1,000      |   | $ | — |   |
| Accrual of  preferred dividend                                                             |       | $                                   | 125        |   | $ | 125 |   |
|                                                                                       |       |                                |       |   |   |
| **Supplemental  disclosure of cash paid during the period for:**                           |       |                                |       |   |   |
| Cash paid  for interest                                                                    |       | $                                   | 142        |   | $ | 178 |   |

 

See accompanying notes to thecondensed consolidated financial statements.

 

5

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**NEORX CORPORATION AND SUBSIDIARY**

 

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1. Basis of Presentation**

 

The accompanying unaudited condensedconsolidated financial statements include the accounts of NeoRx Corporation andsubsidiary (the Company).  Allintercompany balances and transactions have been eliminated in consolidation.

 

Theinterim financial statements contained herein have been prepared pursuant tothe rules and regulations of the Securities and Exchange Commission.  Certain information and note disclosuresnormally included in annual financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted pursuant to those rules and regulations, although theCompany believes that the disclosures made are adequate to make the informationpresented not misleading.  Thesefinancial statements should be read in conjunction with the Company’s annualreport on Form 10-K for the year ended December 31, 2003.

 

In the opinion of management, the interimfinancial statements reflect all adjustments, consisting only of normalrecurring accruals necessary to present fairly the Company’s financial positionas of September 30, 2004 and the results of operations and cash flows for theperiods ended September 30, 2004 and 2003.

 

Theresults of operations for the periods ended September 30, 2004 are notnecessarily indicative of the expected operating results for the full year.

 

Certainprior period amounts have been reclassified to conform to the current yearpresentation.

 

*Stock Based Compensation*: The Company accounts for its stock option plans for employees inaccordance with the provisions of Accounting Principles Board (APB) Opinion No.25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.  Compensation expenserelated to employee stock options is recorded if, on the date of grant, thefair value of the underlying stock exceeds the exercise price.  The Company applies the disclosure-onlyrequirements of Statement of Financial Accounting Standard (SFAS) No. 123, “Accountingfor Stock-Based Compensation”, which allows entities to continue to apply theprovisions of APB Opinion No. 25 for transactions with employees and to providepro forma results of operations disclosures for employee stock option grants asif the fair-value based method of accounting in SFAS No. 123 had been appliedto these transactions.  Stock compensationcosts related to fixed employee awards with pro rata vesting are recognized ona straight-line basis over the period of benefit, generally the vesting periodof the options.  For options and warrantsissued to non-employees, the Company recognizes stock compensation costsutilizing the fair value methodology prescribed in SFAS No. 123 over therelated period of benefit.

 

Had compensation cost for these stockoption plans for employees been determined using the fair value based method ofaccounting under SFAS No. 123, the Company’s net loss applicable to commonshares and net loss per share would have been the pro forma amounts indicatedbelow (in thousands, except per share data):

 
| ** **                                                                                         | ** ** | **Quarter ended   September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                         | ** ** | **2004**                          | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss applicable to common shares:                                                              |       |                              |       |                                 |       |   |   |   |   |
| As reported                                                                                        |       | $                                 | (4,706     | )                                    | $          | (3,248 | ) | $ | (14,468 | ) | $ | (2,287 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss                      |       | —                            |       | —                               |       | 340 |   | 590 |   |
| Deduct: Stock-based employee compensation  determined under fair value based method for all awards |       | (313                              | )          | (494                                 | )          | (1,270 | ) | (2,231 | ) |
| Pro forma                                                                                          |       | $                                 | (5,019     | )                                    | $          | (3,742 | ) | $ | (15,398 | ) | $ | (3,928 | ) |
| Net loss per common share, basic and  diluted:                                                     |       |                              |       |                                 |       |   |   |   |   |
| As reported:                                                                                       |       |                              |       |                                 |       |   |   |   |   |
| Basic and diluted                                                                                  |       | $                                 | (0.15      | )                                    | $          | (0.12 | ) | $ | (0.48 | ) | $ | (0.08 | ) |
| Pro forma:                                                                                         |       |                              |       |                                 |       |   |   |   |   |
| Basic and diluted                                                                                  |       | $                                 | (0.16      | )                                    | $          | (0.14 | ) | $ | (0.51 | ) | $ | (0.15 | ) |

 

6

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The per share weighted-average fair value ofstock options granted during the quarters ended September 30, 2004 and 2003 was$1.67 and $2.42, respectively, and during the nine months endedSeptember 30, 2004 and 2003 was $1.97 and $0.97, respectively.  The fair values were determined as of the grantdate using the Black-Scholes option pricing model with the following weightedaverage assumptions:

 
| ** **              | ** ** | **Quarter ended  September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|-------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
| ** **              | ** ** | **2004**                         | ** ** | **2003**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected dividend rate  |       | 0.0                              | %          | 0.0                                   | %          | 0.0 | % | 0.0 | % |
| Risk-free interest rate |       | 3.14                             | %          | 2.40                                  | %          | 3.42 | % | 2.30 | % |
| Expected volatility     |       | 122.3                            | %          | 140.0                                 | %          | 122.1 | % | 135.6 | % |
| Expected life in years  |       | 4.00                             |       | 4.00                                  |       | 4.00 |   | 4.00 |   |

 

**Note 2. Net Loss Per Common Share**

 

Basic and diluted loss per share are based onnet loss applicable to common shares, which is comprised of net loss and preferredstock dividends in all periods presented. Shares used to calculate basic lossper share are based on the weighted average number of common shares outstandingduring the period.  Shares used tocalculate diluted loss per share are based on the potential dilution that wouldoccur upon the exercise or conversion of securities into common stock using thetreasury stock method.  Calculations ofdiluted loss per share exclude the effect of the following stock options andwarrants to purchase additional shares of common stock because the shareincrements would not be dilutive.

 
| ** **             | ** ** | **Quarter ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **             | ** ** | **2004**                         | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                   |       |                             |       |                                 |       |   |   |   |   |
| Common stock  options  |       | 4,050,285                        |       | 4,431,894                            |       | 4,050,285 |   | 4,431,894 |   |
| Common stock  warrants |       | 1,587,500                        |       | 875,000                              |       | 1,587,500 |   | 875,000 |   |

 

Inaddition, 234,088 shares of common stock that would be issuable upon conversionof the Company’s Series 1 preferred stock are not included in the calculationof diluted loss per share for the periods ended September 30, 2004 and 2003,respectively, and the 3,150,000 shares of common stock that would be issuableupon conversion of the Company’s Series B preferred stock are not included inthe calculation of diluted loss per share for the period ended September 30,2004 because the effect of including such shares would not be dilutive.

 

**Note 3.  Comprehensive Loss**

 

The Company’s comprehensive loss for thequarters ended September 30, 2004 and 2003 was $4,576,000 and $3,100,000,respectively.  The comprehensive loss forthe quarters ended September 30, 2004 and 2003 consisted of net loss of$4,581,000 and $3,123,000, respectively, and a net unrealized gain oninvestment securities of $5,000 and $23,000 for the quarters ended September30, 2004 and 2003, respectively. The comprehensive loss for the nine monthsended September 30, 2004 and 2003 was $14,089,000 and $1,830,000,respectively.  The 

 

7

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comprehensive loss for the nine months ended September 30, 2004 and2003 consisted of net loss of $14,093,000 and $1,912,000, respectively, and anet unrealized gain on investment securities of $4,000 and $82,000 for the ninemonths ended September 30, 2004 and 2003, respectively

 

# **Note 4.  Asset Retirement Obligation**

# ** **

The Company recorded a $0.2 million cumulative effect of change inaccounting principle during the first three months of 2003 as a result of theCompany’s adoption of SFAS No. 143, Accounting for Asset RetirementObligations.  Under SFAS No. 143, theCompany recorded an asset and liability in the amount of $0.4 million relatedto the estimated fair value of future decommissioning costs associated with theDenton, TX radiopharmaceutical manufacturing facility. The real estate andequipment associated with the manufacturing facility for which thedecommissioning costs were estimated were sold in December 2003.  The sale of these assets eliminated thefuture asset retirement obligation as recorded under SFAS 143 as of December31, 2003.  Accretion of the assetretirement obligation totaled $50,000 and depreciation expense for the assetretirement asset totaled $39,000 for the nine months ended September 30, 2003.

 

# **Note 5.  Common Stock Private Placement**

# ** **

In February 2004, the Company raised $9.0million in net proceeds through the sale in a private placement (the 2004Financing) of 1,845,000 shares of common stock. The new common shareholders also received five-year warrants to purchasean aggregate of 922,500 shares of common stock at $7.00 per share.  The warrants are exercisable beginning onFebruary 23, 2004 and, thereafter, are exercisable at any time during theirterm.  The warrants contain provisionsrequiring the adjustment of the exercise price and number of shares issuable ifthe Company sells (other than in connection with certain permittedtransactions, such as strategic collaborations and acquisitions approved by theboard of directors) shares of common stock at a price lower than thethen-current exercise price of the warrants. The warrants are redeemable at the election of the Company at any timeafter March 24, 2006, if the volume-weighted average price of the underlyingcommon stock for each trading day over a period of 20 consecutive trading daysis equal to or greater than $10.50 per share, subject to adjustment.  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.

 

# **Note 6.  Liquidity**

# ** **

TheCompany will need to raise additional capital to fund its Skeletal TargetedRadiotherapy (STRTM) phase III clinical trial and other proposed STR studies,development of its newly acquired platinum-based compound, NX 473 (see Note 7),and future operating cash needs.

 

InApril 2003, the Company received $10 million from the sale to Boston ScientificCorporation of certain non-core NeoRx intellectual property and the grant toBoston Scientific Corporation of certain license rights.  In December 2003, the Company raised approximately$14.6 million in net proceeds through the sale in a private placement of sharesof a newly created class of Series B Convertible Preferred Stock (Series BPreferred Stock), which are convertible, at a price of $5.00 per share, into3,150,000 shares of common stock, and warrants to purchase an aggregate of630,000 common shares at $6.00 per share. The Company raised approximately $9.0 million in net proceeds from thesale of common stock and warrants in a private placement transaction inFebruary 2004.  The Company intends touse the net proceeds from these sources for general working capital and tosupport its STR phase III pivotal trial. With the proceeds of these offerings, the Company believes that itspresent cash, cash equivalents, investment securities and expected interestincome will be sufficient to fund its anticipated working capital and capitalrequirements with respect to its STR multiple myeloma program through the thirdquarter of 2005.  The Company willrequire additional funds for its development of STR for any additional cancerindications and for its NX 473 clinical program, which the Company currentlyplans to begin in the first half of 2005. In the event that sufficient additional funds are not obtained, theCompany may be required to delay, reduce the scope of or curtail its STR andNX 473 clinical programs and other product development efforts.

 

During 2002, the Company discontinued allPretarget clinical and research activities, reduced staffing by 67% andterminated, effective in April 2003, the lease for its facilities at 410 WestHarrison Street in Seattle.  Pretargettechnology is a development platform for targeted immunotherapeutics thatdeliver intense doses of anti-cancer agents to tumor cells while largelysparing healthy tissues.  Sincediscontinuation of the Pretarget program, the Company actively sought, boththrough targeted inquires and a broad-based auction process, a buyer orlicensee 

 

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for the technology.  In April2004, the Company, in a negotiated arms-length transaction, sold the Pretargetpatent portfolio to Aletheon Pharmaceuticals, Inc., a start-up company foundedby two former Company employees.  TheCompany did not receive cash at the time of sale to Aletheon. The Company couldreceive up to $6.6 million in milestone payments if Aletheon achieves certaindevelopment goals, plus royalties on potential future product sales The sale ofthe Pretarget intellectual property relieves the Company from the annual costsof maintaining the Pretarget patent estate. In 2003, the Company spent approximately $350,000 for the prosecutionand maintenance of the Pretarget patents and trademarks.  For 2004, these costs were expected to be inthe range of $200,000 to $600,000.  SeeNote 7 below for additional information about the Pretarget transaction.

 

In connection with its 2001 purchase of theradiopharmaceutical manufacturing plant and other assets located in Denton, TX,the Company assumed $6,000,000 principal amount of restructured debt held byTexas State Bank, McAllen, TX.  The loan,which matures in April 2009, is secured by the assets acquired in thetransaction.  The interest rate on theloan was 4.75% on September 30, 2004. The interest rate is equal to the bank prime rate and adjusts on thesame date that the bank prime rate changes. 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 quarters ended September 30, 2004 and 2003 totaled$115,000 and $139,000, respectively. Principal and interest paid on the noteduring the nine months ended September 30, 2004 and 2003 totaled $370,000 and$463,000, respectively.  InDecember 2003, the Company sold a non-essential portion of its Dentonfacility, the proceeds of which ($827,000) were applied to reduce theoutstanding balance on the loan.  As ofSeptember 30, 2004 the outstanding balance of the loan was $4,270,000.  The fixed monthly payments on the note arerecalculated in April of each year based on the then current bank primeinterest rate and outstanding note balance. The bank prime interest rate of 4.00% was in effect on the paymentrecalculation date, resulting in an estimated total fixed payment obligation in2004, reflecting both principal and interest, of $486,000.

 

During 2002 and early 2003, the Companyreduced the staff at the Denton facility to four employees and operated thefacility in standby mode.  In the secondhalf of 2003, the Company re-staffed the facility in preparation for resumptionof manufacturing activities in the first quarter of 2004.  The terms of the Texas State Bank loanprovide that an event of default may be deemed to occur if the Companyabandons, vacates or discontinues operations on a substantial portion of theDenton facility or there is a material adverse change in the Company’soperations. The Company does not believe that operating the facility in standbymode during 2002 and early 2003 violated these provisions, nor has Texas StateBank suggested that it views such activities as a potential violation. TheCompany can provide no assurance, however, that Texas State Bank will not atsome time in the future seek to rely on these or other provisions of the loanto declare the Company in default of the loan. If this were to occur, TexasState Bank could declare the entire outstanding amount of the loan ($4,270,000at September 30, 2004) due and immediately payable. In such case, the Company’scash resources and assets could be impaired depending on its ability to obtainan alternative source of financing for the facility.  Based on a November 2002 appraisal ofthe Denton facility, the fair value of the facility and its assets exceeds theamount of the outstanding debt. The Company may seek to raise capital throughadditional sales of equity and/or debt securities or the establishment of otherfunding mechanisms. The Company is seeking to form strategic partnerships forSTR and NX 473 development and commercialization.  The Company also may address its need foradditional capital by pursuing opportunities for the licensing, sale ordivestiture of certain non-core intellectual property and other assets.  In the event that sufficient additional fundsare not obtained through the sales of securities, strategic partneringopportunities, licensing arrangements and/or sales of assets on a timely basis,the Company plans to reduce expenses through the delay, reduction orcurtailment of its product development activities and/or further reduction ofcosts for facilities and administration.

 

Our actual capital requirements will depend uponnumerous factors, including:

 

•    the rate ofprogress and costs of our clinical trial and research and developmentactivities, including our ability to activate clinical sites and enrollqualified patients into our STR phase III clinical trial;

 

•    our ability toobtain clinical material from third-party suppliers and manufacture STR in atimely and cost-effective manner;

 

•    actions taken bythe FDA and other regulatory authorities;

 

•    the scope andtiming of our NX 473 development program clinical trials and other research and

 

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developmentefforts;

 

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

 

•    the timing andamount of any milestone or other payments we might receive from existing andpotential strategic partners and licensees;

 

•    our degree ofsuccess in commercializing STR and other cancer therapy product candidates;

 

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

 

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

 

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

 

# **Note 7.  Purchase and Sale of Intellectual Property**

# ** **

Licensed Products represent the worldwide exclusiverights, excluding Japan, to develop, manufacture and commercialize NX 473, aplatinum-based anti-cancer agent, acquired from AnorMED, Inc., in April 2004and are accounted for at cost, less accumulated amortization.  Amortization is computed on a straight-linebasis over an estimated useful life of twelve years.  In April 2004, under the terms of thelicensing agreement with AnorMED, the Company paid a one-time upfront milestonepayment of $1 million in NeoRx common stock and $1 million in cash.  The agreement also provides milestonepayments to AnorMED of up to $13 million, payable in cash or a combination ofcash and NeoRx common stock.  Uponregulatory approval, AnorMED would receive royalty payments of up to 15% onproduct sales.  Under the agreement, theCompany acquired an exclusive license, under a portfolio of issued patents andpatent applications, to develop, manufacture and commercialize NX 473.  The agreement also exclusively licenses tothe Company certain know-how pertaining to NX 473, including clinical andmanufacturing data, regulatory submissions, and related information.

 

Also in April 2004, the Company sold to AletheonPharmaceuticals, Inc. the Company’s Pretarget intellectual property.  Under the agreement, the Company couldreceive up to $6.6 million in milestone payments if Aletheon achieves certaindevelopment goals, plus royalties on potential future product sales. The timingand amount of milestone and royalty payments, if any, are uncertain.  The Company did not receive cash at the timeof sale to Aletheon.  The Pretargetintellectual property that the Company transferred to Aletheon under theagreement includes a portfolio of United States and foreign issued patents andpatent applications, and trademark registrations and applications.  The sale of the Pretarget intellectualproperty relieves the Company from the significant annual costs of maintainingthe Pretarget patent estate. Seattle-based Aletheon is a development stagebiotherapeutics company founded by two former Company employees. The terms ofthe transaction were determined through arms-length negotiation.  Neither the Company nor Bay City Capital LLCand its affiliates at any time has held, or in the future plans to acquire, afinancial interest in Aletheon.  TheCompany discontinued its Pretarget development activities and clinical studiesin July 2002.

 

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**Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

ThisForm 10-Q contains forward-looking statements. These statements relate tofuture events or future financial performance. In some cases, you can identifyforward-looking statements by terminology such as “may,” “will,” “should,” “expect,”“plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “propose”or “continue,” the negative of these terms or other terminology.  These statements are only predictions. Actualevents or results may differ materially. In evaluating these statements, youshould specifically consider various factors described below in the sectionentitled “Additional factors that may affect results.” These factors may causeour actual results to differ materially from any forward-looking statement.

 

Althoughwe believe the expectations reflected in the forward-looking statements arereasonable, we cannot guarantee future results, levels of activity, performanceor achievements. You should not place undue reliance on our forward-lookingstatements, which speak only as of the date of this report.  We undertake no obligation to update publiclyany forward-looking statements to reflect new information, events orcircumstances after the date of this report, or to reflect the occurrence ofunanticipated events.

 

NeoRxand STR are our trademarks or registered trademarks in the United States and/orforeign countries.  Pretarget is atrademark of Aletheon Pharmaceuticals, Inc. in the United States and/or foreigncountries.

 

***Critical Accounting Policies and Estimates***

 

Ourcritical accounting policies and estimates have not changed from those reportedin our Annual Report on Form 10-K for the year ended December 31, 2003.  For a more complete description, please referto our Annual Report on Form 10-K.

 

###### ***Quarter and nine months ended September 30, 2004compared to quarter and nine months ended September 30, 2003***

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

Revenue forthe third quarter of 2004 was $5,000 compared to $225,000 for the third quarterof 2003.  Revenue for the nine monthsended September 30, 2004 was $1.0 million compared to $10.5 million for thenine months ended September 30, 2003. Revenue for the first nine months of 2004 consisted primarily ofmilestone payments from Boston Scientific Corporation.  Revenue for the third quarter of 2003consisted of revenue from a facilities lease, while revenue for the first ninemonths of 2003 consisted of $10.0 million from the assignment and license toBoston Scientific Corporation of certain non-core intellectual property and$0.5 million from a facilities lease.

 

Totaloperating expenses for the third quarter of 2004 increased to $4.6 million,from $3.2 million for the third quarter of 2003, and increased to $15.2 millionfor the nine months ended September 30, 2004, from $12.1 million for the sameperiod in 2003.

 

Researchand development expenses increased to $3.1 million for the third quarter of2004, from $2.0 million for the third quarter of 2003.  The increase in R&D expenses for thethird quarter of 2004 resulted from increased costs primarily related to theSTR phase III trial, including a $0.2 million increase in drug compound costs,a $0.4 million increase in Clinical Research Organization (CRO) costs and a$0.4 million increase in consulting activity. Research and development expenses for the nine months ended September30, 2004 increased to $10.0 million, from $7.4 million for the same period in2003 due to the same activities, including a $1.0 million increase inconsulting activity, a $0.9 million increase in manufacturing facilityvalidation and preparation expense and a $0.7 million increase in drug compoundcosts.

 

General andadministrative expenses increased to $1.5 million for the third quarter of2004, compared to $1.1 million for the third quarter of 2003, and increased to$5.2 million for the nine months ended September 30, 2004, from $4.7 millionfor the same period in 2003.  Theincrease in G&A costs for the quarter ended September 30, 2004 resultedprimarily from a $0.1 million increase in consulting activity and a $0.2million increase in personnel recruiting activity.  The increase in G&A costs for the ninemonths ended September 30, 2004 resulted primarily from a $0.3 million increasein recruiting activities, a $0.2 million increase in consulting activity and a$0.1 increase in accounting fees, offset by a $0.3 million decrease inpersonnel costs.

 

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Cash and investment securities as of September 30, 2004 were $22.1million, compared to $27.5 million at December 31, 2003.

 

***Major Research and Development Projects***

 

Our major research and development projectduring the fiscal quarters ended September 30, 2004 and 2003 was SkeletalTargeted Radiotherapy(STRTM).

 

We are developing STR for the treatment of multiple myeloma, acancer originating in the bone marrow. STR is designed to deliver radiation specifically to sites of cancer inthe bone and bone marrow.  STR consistsof a bone-seeking molecule called DOTMP, which deposits the radioactivesubstance, holmium-166, in the skeleton. We haveincurred costs of approximately $50.6 million in connection with the STRprogram since the program’s inception in 1998.

 

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

 

Weopened the phase III trial of STR to patient enrollment in March 2004 and planto conduct the trial at multiple sites in the US and Canada.  We do not plan to announce the opening ofclinical sites or the enrollment of patients. We anticipate that the phase III trial will take several years tocomplete, and we do not expect to submit a New Drug Application (NDA) beforemid-2007 for the potential approval of STR by the FDA.  The actual time to completion of our STRphase III clinical trial depends upon numerous factors including:

 

 

•    our ability toidentify and enroll patients who meet trial eligibility criteria;

 

•    our ability toobtain adequate additional funding;

 

•    our receipt ofapprovals by the FDA and other regulatory agencies and the timing thereof;

 

•    other actions byregulators;

 

•    the rate ofprogress and costs of our other clinical trial and research and developmentactivities;

 

•    our ability toproduce sufficient, reliable and affordable supplies of the STR compound forclinical studies, and to access third-party supplies of holmium-166, theradioactive substance used in our STR product candidate, as well as othermaterials used in the manufacture of the STR compound;

 

•    the costs ofmaintaining manufacturing operations;

 

•    the extent ofscheduling conflicts with participating clinicians and clinical institutions.

 

Total estimated costs tocomplete the STR clinical trial and potentially obtain marketing approval arein the range of $35-40 million, including the cost of clinical drugsupply.  These costs could besubstantially higher if we have to repeat, revise or expand the scope of ourtrials, or conduct additional clinical trials not presently planned, to securemarketing approvals.  These estimatedcosts exceed our current capital resources and we will be required to obtainadditional funding to complete the STR clinical trial.

 

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To date, we have notreceived any revenues from product sales of STR and do not expect any materialcash inflows relating to our STR development activities until after marketingapprovals are obtained, if they are obtained, and then only if STR findsacceptance in the marketplace.

 

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

 

•    STR may not beshown to be safe and efficacious in the phase III trial;

 

•    We may be unableto obtain regulatory approval of the drug or may be unable to obtain such approvalon a timely basis;

 

•    We may be unableto continue to manufacture or otherwise secure adequate supplies of STR inorder to complete the phase III clinical trial and initiate commercial launchupon approval;

 

•    We may be unableto recruit enough patients to complete the phase III trial in a timely manner;and

 

•    We may not haveadequate funds to complete the development of STR.

 

If we fail to obtainmarketing approval for STR, are unable to secure adequate clinical andcommercial supplies of STR, or do not complete development and obtainregulatory approval on a timely basis, our operations, financial position andliquidity could be severely impaired, including as follows:

 

•    We would not earnany sales revenue from STR, which would increase the likelihood that we wouldneed to obtain additional financing for our other development efforts; and

 

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

 

Because of the many risksand uncertainties relating to the completion of clinical trials, receipt ofmarketing approvals and acceptance in the marketplace, we cannot predict theperiod in which material cash inflows from our STR program will commence, ifever.

 

Our developmentadministration overhead costs, consisting of rent, utilities, consulting fees,patent costs and other various overhead costs, are included in total researchand development expense for each period, but are not allocated among ourvarious projects.  Our total developmentcosts include the costs of various other research efforts directed toward theidentification of future product candidates. These other research projects are pre-clinical and not considered majorprojects.  Our total research and developmentcosts are summarized below:

 
| ** **                            | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
| **(000’s)**                      | ** ** | **2004**                         | ** ** | **2003**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                  |       |                             |       |                                  |       |   |   |   |   |
| STR                                   |       | $                                | 2,479      |                                  | $          | 1,359 |   | $ | 7,850 |   | $ | 4,494 |   |
| Other  overhead and research costs    |       | 639                              |       | 678                                   |       | 2,159 |   | 2,882 |   |
|                                  |       |                             |       |                                  |       |   |   |   |   |
| Total  research and development costs |       | $                                | 3,118      |                                  | $          | 2,037 |   | $ | 10,009 |   | $ | 7,376 |   |

 

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###### ***Liquidity and capital resources***

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

The Company has financed its operationsprimarily through the sale of equity securities, technology licensing,collaborative agreements and debt instruments. We invest excess cash in investment securities that will be used to fundfuture operating costs.  Cash, cashequivalents and investment securities totaled $22.1 million at September 30,2004 compared to $27.5 million at December 31, 2003.  We primarily fund current operations with ourexisting cash and investments.  Cash used by operating activitiesfor the nine months ended September 30, 2004 totaled $13.1 million.  Revenues and other income sources for thethird quarter of 2004 were not sufficient to cover operating expenses. Webelieve that our available cash, investment securities and interest income willbe sufficient to fund our anticipated working capital and capital requirementswith respect to our STR multiple myeloma program through the third quarter of2005, but will not be sufficient to complete our STR phase III clinical trial,which we estimate will cost $35 to 40 million, including the cost of clinicaldrug supply.  We will require additionalfunds for development of STR for any additional cancer indications and for ourNX 473 clinical program, which currently is expected to begin in the first halfof 2005.  In the event that sufficientadditional funds are not obtained, we may be required to delay, reduce orcurtail the scope of our STR and NX 473 clinical programs and otherproduct development efforts.

 

OnApril 17, 2003, we entered into agreements with Boston Scientific Corporationrelating to the sale to Boston Scientific of certain non-core intellectualproperty and the grant to Boston Scientific of certain license rights. Underthe first agreement, we assigned to Boston Scientific certain intellectualproperty in exchange for a cash payment of $9 million.  The intellectual property assigned to BostonScientific included a portfolio of NeoRx patents and patent applications in thecardiovascular field. Under a second agreement, we granted to Boston Scientifican exclusive license to use certain other NeoRx intellectual property, forwhich we received a one-time cash payment of $1 million.  The exclusive license grants BostonScientific the right to use, in certain medical device fields, a separateportfolio of NeoRx patents and patent applications resulting from ourcollaboration with University of Cambridge investigators.

 

In December 2003, we raised approximately$14.6 million in net proceeds through the sale in a private placement of sharesof a newly created class of Series B Convertible Preferred Stock, which areconvertible, at a price of $5.00 per share, into 3,150,000 shares of commonstock, and warrants to purchase an aggregate of 630,000 common shares at $6.00per share.  Additionally, we raisedapproximately $9.0 million in net proceeds from the sale of common stock andwarrants in a private placement transaction in February 2004.  We intend to use the net proceeds from thesefinancings for general working capital and to support our STR phase III pivotaltrial.

 

In connection with our 2001 purchase of theradiopharmaceutical manufacturing plant and other assets located in Denton, TX,we assumed $6,000,000 principal amount of restructured debt held by Texas StateBank, McAllen, TX.  The loan, whichmatures in April 2009, is secured by the assets acquired in thetransaction.  The interest rate on theloan was 4.75% on September 30, 2004. The interest rate is equal to the bank prime rate and adjusts on thesame date that the bank prime rate changes. 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 quarters ended September 30, 2004 and 2003 totaled$115,000 and $139,000, respectively. Principal and interest paid on the note during the nine months endedSeptember 30, 2004 and 2003 totaled $370,000 and $463,000, respectively. InDecember 2003 we sold a non-essential portion of our Denton facility. Theproceeds of the sale, $827,000, were applied to reduce the outstanding balanceon the loan. As of September 30, 2004, the outstanding balance of the loan was$4,270,000. The fixed monthly payments on the note are recalculated in April ofeach year based on the then current bank prime interest rate and outstandingnote balance. The bank prime interest rate of 4.00% was in effect on thepayment recalculation date in April 2004, resulting in an estimated total fixedpayment obligation in 2004, reflecting both principal and interest, of$486,000.

 

During 2002 and early 2003, we reduced the staffat the Denton facility to four employees and operated the facility in standbymode.  In the second half of 2003, were-staffed the facility in preparation for resumption of manufacturingactivities in the first quarter of 2004. The terms of the Texas State Bank loan provide that an event of defaultmay be deemed to occur if we abandon, vacate or discontinue operations on asubstantial portion of the Denton facility or there is a material adversechange in our operations.  We do notbelieve that operating the facility in standby mode during 2002 and early 2003violated these provisions, nor has Texas State Bank suggested that it viewssuch activities as a potential violation. We can provide no assurance, however, that Texas State Bank will notsome time in the future seek to rely on these or other provisions of the loanto declare us in default of the loan.  Ifthis were to occur, Texas State Bank could declare the entire outstandingamount of the loan ($4,270,000 at 

 

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September 30, 2004) due and immediately payable. In such case, our cashresources and assets could be impaired depending on our ability to raise fundsthrough a sale of the Denton facility and other means.  Based on a November 2002 appraisal ofthe Denton facility, the fair value of the facility and its assets exceeds theamount of the outstanding debt.

 

InApril 2004, we acquired from AnorMED, Inc. the worldwide exclusive rights,excluding Japan, to develop, manufacture and commercialize NX 473, aplatinum-based anti-cancer agent.  Underthe terms of the agreement, we paid AnorMED a one-time upfront milestonepayment of $1.0 million in our common stock and $1.0 million in cash.  The agreement also provides for additionalmilestone payments to AnorMED of up to $13 million, payable in cash or acombination of cash and our common stock. Upon regulatory approval, AnorMED would receive royalty payments of upto 15% on product sales.  In phase IItrials conducted by the prior licensee of the compound, NX 473 has been shownto be active in a variety of cancers, including ovarian cancer, lung cancer andprostate cancer.  NX 473 also exhibitsthe potential to be available in both oral and intravenous formulations. Wefiled an IND application for NX 473 in October 2004 for a phase II study inlung cancer.  We also plan to file thisyear an IND for a phase I/II study in colorectal cancer.  The timing and scope of those studies willdepend in part on our ability to raise capital, obtain required FDA approvaland secure a contractor to fill and finish bulk drug substance.  We are currently having fill-and-finish ofthe intravenous formulation of the drug performed by a contract manufacturer.  We expect the drug to be available forclinical studies in the first half of 2005.

 

Also in April 2004, we sold and transferred toAletheon Pharmaceuticals, Inc. our Pretarget intellectual property.  Under the agreement, we could receive up to$6.6 million in milestone payments if Aletheon achieves certain developmentgoals, plus royalties on potential future product sales.  We did not receive any upfront considerationfor the sale of the Pretarget property. We discontinued our clinical studies using the Pretarget technology inJuly 2002, and since that time, had been actively seeking, both throughtargeted inquiries and a broad-based auction process, a buyer or licensee forthe technology.  The sale of thePretarget intellectual property relieves us of the annual costs associated withmaintaining the Pretarget patent estate. During 2003, the Company spent approximately $350,000 for theprosecution and maintenance of the Pretarget patents and trademarks.  For 2004, these costs were expected to be inthe range of $200,000 to $600,000. Seattle-based Aletheon is a development-stage biotherapeutics companyfounded by two former NeoRx employees. The timing and amount of milestone payments, if any, are uncertain.  The terms of the transaction were determinedthrough arms-length negotiation.  Neitherthe Company nor Bay City Capital LLC and its affiliates at any time has held,or in the future plans to acquire, a financial interest in Aletheon.

 

We will need to raiseadditional capital to fund our STR phase III clinical trial and other proposedSTR studies, development of our recently-acquired platinum-based compound, NX473, and future operating cash needs.  Wemay seek to raise capital through the sale of equity and/or debt securities orthe development of other funding mechanisms. We are seeking to form strategicpartnerships for STR and NX 473 development and commercialization.  We may also address our need for additionalcapital by pursuing opportunities for the licensing, sale or divestiture ofcertain non-core intellectual property and other assets.  In the event that sufficient additional fundsare not obtained through strategic partnering opportunities, sales ofsecurities, licensing arrangements and/or sales of assets on a timely basis, weplan to reduce expenses through the delay, reduction or curtailment of our productdevelopment activities and/or further reduction of costs for facilities andadministration.

 

Our actual capital requirements will depend uponnumerous factors, including:

 

•    the rate ofprogress and costs of our clinical trial and research and developmentactivities, including our ability to activate clinical sites and enrollqualified patients into our STR phase III clinical trial;

 

•    our ability toobtain clinical material from third-party suppliers and manufacture STR in atimely and cost-effective manner;

 

•    actions taken bythe FDA and other regulatory authorities;

 

•    the scope andtiming of our NX 473 development program clinical trials and other research anddevelopment efforts;

 

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

 

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•    the timing andamount of any milestone or other payments we might receive from existing andpotential strategic partners and licensees;

 

•    our degree ofsuccess in commercializing STR and other cancer therapy product candidates;

 

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

 

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

 

We may not be able to obtain the required 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 our potential financing sources andopportunities for strategic partnering. Our financial statements are prepared on a going concern basis; however,if we are forced to liquidate our assets, we may not be able to recover thecarrying amount of such assets.

 

***Related party transactions***

 

Dr. Frederick Craves, adirector of the Company, is a founder and current chairman of the board of BayCity Capital, LLC, also known as BCC, a merchant bank focused on the lifesciences industry.  Dr. Carl Goldfischer,also a Company director, is a managing director of BCC.  Jack Bowman, who retired as NeoRx’s ChiefExecutive Officer and Chairman of the Board of Directors in May 2004, was onthe business advisory board of BCC.  TheCompany and BCC entered into an agreement whereby BCC acted as the Company’sadvisor for the purpose of identifying opportunities to enter into strategicalliances and provided assistance relating to structuring and negotiating suchtransaction. The Company paid a retainer fee of $26,667 for the first quarterof 2003 and $25,000 for each quarter thereafter to the end of 2003. Retainerfee expenses under this agreement totaled $101,667.  The agreement also included a percentage ofgross value of cash, securities, property or other consideration derived from atransaction, ranging from one to five percent, depending on the ultimate amountof consideration raised.  BCC agreed toexclude the Boston Scientific Corporation sale and assignment of intellectualproperty from this provision of its agreement with the Company, and, therefore,received no commission or other compensation related to the Boston Scientifictransaction.  This agreement expiredDecember 31, 2003, and the Company has elected not to renew it.  The Company believes that the fees associatedwith this contract are equivalent to market prices for similar service atindependent investment banks.

 

In connection with consulting servicesperformed in 2003, Dr. Paul G. Abrams, a former Chief Executive Officer of theCompany, received consulting fees of approximately $25,500 for the quarterended September 30, 2003.  This agreementterminated on July 31, 2003.

 

In connection with consulting servicesperformed in 2003, Becky J. Bottino, former Senior Vice President of TechnicalOperations, received consulting fees of approximately $7,500 for the quarterended September 30, 2003.  This agreementterminated on September 15, 2003.

 

In connection with consulting servicesperformed in 2003, Richard L. Anderson, former Senior Vice President, ChiefFinancial Officer and Secretary, received consulting fees of approximately$57,000 for the quarter ended September 30, 2003.  This agreement terminated on October 7, 2003.

 

On June 26, 2003, the compensation committeeapproved effective with the resignation of Dr. Douglass B. Given, formerly theCompany’s President and Chief Executive Officer, on June 30, 2003, theaccelerated vesting of all outstanding stock options granted by the Company to Dr.Given. These options were exercisable until June 30, 2004.  Mr. Given exercised 232,570 of these optionsthrough June 2004.  The balance of theseoptions was not exercised and expired on June 30, 2004.

 

On April 9, 2004, the compensation committeeapproved effective with the resignation of Melinda G. Kile, formerly the VicePresident of Finance, the extension of time to exercise all stock optionsgranted by the Company to Ms. Kile that were vested at the time of herresignation.  These options are exercisableuntil December 31, 2004.

 

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***Additional factors that may affect results***

 

In addition to the other informationcontained in this report, you should carefully read and consider the followingrisk factors before purchasing our common stock. Each of these******risks could harm ourbusiness,******operatingresults and financial condition, as well as decrease the value of an investmentin our stock.  An investment in NeoRxsecurities involves a high degree of risk.

 

**Risks Related to Our Business**

 

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

 

We have not been profitable since ourformation in 1984. As of September 30, 2004, we had an accumulated deficit of$228.9 million. Our net loss for the quarter ended September 30, 2004 was$4.6 million.  We had net losses of $5.1million for the year ended December 31, 2003, $23.1 million for the yearended December 31, 2002, and $23.8 million for the year ended December 31,2001. These losses have resulted principally from costs incurred in ourresearch and development programs and from our general and administrativeactivities. To date, we have been engaged only in research and developmentactivities and have not generated any significant revenues from product sales.We do not anticipate that our proposed STR product will be commerciallyavailable for several years, if at all. We expect to incur additional operatinglosses in the future. These losses may increase significantly if we expandclinical development, manufacturing and commercialization efforts.

 

Our ability to achieve long-termprofitability is dependent upon obtaining regulatory approvals for our STRproduct candidate and any other proposed products and successfullycommercializing our products alone or with third parties.

 

**Wewill need to raise additional capital, and our future access to capital isuncertain.**

** **

It is expensive to develop cancer therapyproducts and conduct clinical trials for these products. Total estimated coststo complete the STR phase III clinical trial and potentially obtain marketingapproval are in the range of $35-40 million, including the cost ofclinical drug supply. These costs could be substantially higher if wehave to repeat, revise or expand the scope of our trials, or conduct additionalclinical trials not presently planned, to secure marketing approvals.  Althoughwe currently are focusing on our STR product candidate for multiple myeloma, weplan in the future to simultaneously conduct clinical trials and preclinicalresearch for a number of different indications and cancer therapy products,which is costly. Our future revenues may not be sufficient to support theexpense of our operations and the conduct of our clinical trials andpreclinical research. We will need to raise additional capital to:

 

•    fund operations;

 

•    continue researchand development of STR and any other product candidates;

 

•    commercialize STRor any other proposed products; and

 

•    develop andimplement a clinical program for our recently-acquired NX 473 platinumcompound.

 

We believe that our available cash andinvestment securities will be sufficient to fund our anticipated workingcapital and capital requirements with respect to our STR phase III programthrough the third quarter of 2005.  Inthe event that sufficient additional funds are not obtained, we may be requiredto delay, reduce or curtail the scope of our STR and NX 473 developmentprograms, including any clinical trials, and other product development efforts.The amount of additional financing we need will depend on a number of factors,including the following:

 

•    the rate ofprogress and costs of our clinical trial and research and developmentactivities, including our ability to activate clinical sites and enrollqualified patients into our STR phase III clinical trial;

 

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•    our ability toobtain clinical material from third-party suppliers and manufacture STR in atimely and cost-effective manner;

 

•    actions taken bythe FDA and other regulatory authorities;

 

•    the scope andtiming of our NX 473 clinical program and other research and developmentefforts;

 

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

 

•    the timing andamount of any milestone or other payments we might receive from existing andpotential strategic partners and licensees;

 

•    our degree ofsuccess in commercializing STR and other cancer therapy product candidates;

 

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

 

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

 

We may not be able to obtain additionalfinancing on a timely basis, on favorable terms, or at all. If we are unable toraise additional funds when we need them, we may be required to delay, reduceor eliminate some or all of our development programs and some or all of ourclinical trials. For example, in July 2002, in order to preserve limitedresources, we curtailed our Pretarget product development program. Thediscontinued Pretarget activities included our Pretarget® Lymphoma andPretarget® Carcinoma phase I/II clinical studies and manufacturing developmentactivities associated with the Pretarget programs. At the time of programtermination, we had completed phase I safety studies for Pretarget Lymphoma inpatients with non-Hodgkin’s lymphoma and for Pretarget Carcinoma in patientswith gastrointestinal adenocarcinoma. We may in the future be forced by costconsiderations and limited access to funding to, as occurred with the Pretargetprogram, discontinue development and testing of product candidates in which wehave invested considerable time and money. Additionally, we may be forced topartner with third parties to develop or commercialize products or technologiesthat we otherwise would have sought to develop independently. Suchrelationships may not be on terms as commercially favorable to us as mightotherwise be the case. If we raise additional funds by issuing common stock orsecurities convertible into or exercisable for common stock, further dilutionto shareholders may result, and new investors could have rights superior tocurrent security holders.

 

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

** **

The manufacture and marketing of our proposedSTR product and our research and development activities are subject toregulation for safety, efficacy and quality by the FDA in the United States andcomparable authorities in other countries.

 

The process of obtaining FDA and otherrequired regulatory approvals, including foreign approvals, is expensive, oftentakes many years and can vary substantially depending on the type, complexityand novelty of the products involved. Our STR product candidate is novel;therefore, regulatory agencies lack direct experience with it. This maylengthen the regulatory review process, increase our development costs anddelay or prevent commercialization of our STR product candidate.

 

In October 2000, the FDA placed all of ourclinical trials of STR on clinical hold because of a serious toxicity thatdeveloped in about 10% of patients treated with STR on our STR phase I/IItrials in multiple myeloma. This toxicity, which is called thromboticthrombocytopenic purpura/hemolytic uremic syndrome (TTP/HUS), emerged six to13  months after treatment. As a condition to lifting the clinical hold,the FDA requested that we collect additional data from a small number ofmultiple myeloma patients to validate the patient-specific dosing method weused in earlier studies of STR and which we proposed to use in our plannedpivotal trial program. In addition, the FDA asked us to quantify the exposureof certain organs, including the kidney, the bone and the bone marrow, toradiation from STR. Quantification of the exposure of internal organs toradiation is called dosimetry. 

 

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The dosimetry study also used an adjusted radiation dosage and arevised administration regimen. We submitted data from our dosimetry study tothe FDA in February 2003, along with a proposal for further clinicaldevelopment of STR in patients with primary refractory myeloma (myeloma thathas not been responsive to conventional first-line chemotherapy), using a reviseddosing method. The FDA lifted the clinical hold in April 2003.

 

TTP/HUS is a syndrome that sometimes occursin patients conditioned for bone marrow transplant with total body irradiation.It is believed to be caused, at least in part, by radiation injury to thekidneys. Of the seven patients who developed TTP/HUS believed to be related totreatment with STR, two were alive at last follow-up in 2003. Three patientsdied with disease progression, making it difficult to determine the cause ofdeath, and two patients died without disease progression, suggesting thatTTP/HUS may have been a cause of death. Our studies indicated that theoccurrence of drug-related TTP/HUS in the phase I/II trials was dependent onthe dose of STR administered. The lowest dose at which drug-related TTP/HUSoccurred was 938 mCi/m2. In the phase III trial, the dose of STR has beenreduced to a fixed dose of 750 mCi/m2. No cases of drug-related TTP/HUS havebeen seen among the ten patients treated in the phase I/II studies atcomparable doses of STR.

 

No cancer product using our technologies hasbeen approved for marketing. Consequently, there is no precedent for thesuccessful commercialization of products based on our technologies. Inaddition, we have had only limited experience in filing and pursuingapplications necessary to gain regulatory approvals. This may impede ourability to obtain timely approvals from the FDA or foreign regulatory agencies.We will not be able to commercialize our STR product candidate until we obtainregulatory approval, and consequently any delay in obtaining, or inability toobtain, regulatory approval could harm our business.

 

If we violate regulatory requirements at anystage, whether before or after marketing approval is obtained, we may be fined,forced to remove a product from the market or experience other adverseconsequences, including delay, which could materially harm our financialresults. Additionally, we may not be able to obtain the labeling claimsnecessary or desirable for product promotion. In addition, if we or otherparties identify serious side effects after any of our products are on themarket, or if manufacturing problems occur, regulatory approval may bewithdrawn and reformulation of our products, additional clinical trials,changes in labeling of our products, and/or additional marketing applicationsmay be required.

 

The requirements governing the conduct ofclinical trials and manufacturing and marketing of our proposed STR productoutside the United States vary widely from country to country. Foreignapprovals may take longer to obtain than FDA approvals and can involveadditional testing. Foreign regulatory approval processes include all of therisks associated with the FDA approval processes. Also, approval of a productby the FDA does not ensure approval of the same product by the healthauthorities of other countries.

 

**Wemay take longer to complete our clinical trials than we project, or we may beunable to complete them at all.**

** **

We opened the phase III trial of STR topatient enrollment in March 2004 and plan to conduct the trial at multiplesites in the US and Canada. There is a limited number of patients with primaryrefractory myeloma who will be qualified for enrollment in our phase IIIclinical trial. We will need to open a significant number of clinical sites toenroll enough patients to complete the study. We may not be able to enrollenough qualified patients to complete the clinical trial in a timely manner, orat all. We do not plan to announce the opening of clinical sites or theenrollment of patients.  We anticipatethat the phase III trial will take several years to complete and we do notexpect to submit a New Drug Application (NDA) before mid-2007 for the potentialapproval of STR by the FDA.  The actualtime to completion of our STR phase III clinical trial depends upon numerousfactors, including:

 

•    our ability to identifyand enroll patients who meet trial eligibility criteria;

 

•    our ability toobtain adequate additional funding;

 

•    our receipt ofapprovals by the FDA and other regulatory agencies and the timing thereof;

 

•    other actions byregulators;

 

•    the rate ofprogress and costs of our other clinical trial and research and developmentactivities;

 

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•    our ability toproduce sufficient, reliable and affordable supplies of the STR compound forclinical studies, and to access third-party supplies of holmium-166, theradioactive substance used in our STR product candidate, as well as othermaterials used in the manufacture of the STR compound;

 

•    the costs ofmaintaining manufacturing operations;

 

•    the extent ofscheduling conflicts with participating clinicians and clinical institutions.

 

We may not advance or complete our plannedphase III clinical trial for our STR product candidate as projected, may notconduct it successfully, or may not complete it at all.

 

We currently rely on academic institutionsand clinical research organizations to conduct, supervise or monitor some orall aspects of clinical trials involving our proposed STR product. Further, weare seeking to enter into license agreements, partnerships or othercollaborative arrangements to support financing, development andcommercialization of our STR product candidate. To the extent that we now or inthe future participate in such collaborative arrangements, we will have lesscontrol over the timing, planning and other aspects of our clinical trials. Ifwe fail to advance or complete, or experience delays in or are forced tocurtail our planned clinical programs, our stock price and our ability toconduct our business could be harmed.

 

**Iftesting of a particular product does not yield successful results, we will beunable to commercialize that product.**

** **

Our research and development programs aredesigned to test the safety and efficacy of our proposed products in humansthrough extensive preclinical and clinical testing. We may experience numerousunforeseen events during, or as a result of, the testing process that coulddelay or prevent commercialization of STR or any other proposed products,including the following:

 

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

 

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

 

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

 

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

 

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

 

Clinical testing is very expensive, can takemany years, and the outcome is uncertain. The data that we may collect from ourphase III clinical trial may not be sufficient to support regulatory approvalof our proposed STR product. The clinical trials of our STR product and otherproposed products may not be completed on schedule, and the FDA or foreignregulatory agencies may not ultimately approve any of our product candidatesfor commercial sale. Our failure to adequately demonstrate the safety andefficacy of a cancer therapy product under development would delay or preventregulatory approval of the product, which would prevent us from marketing theproposed product.

 

**Success in preclinical testing and earlyclinical trials may not be indicative of results obtained in later trials.**

 

Results of early preclinical and clinicaltrials are based on a limited number of patients and may, upon review, berevised or negated by authorities or by later stage clinical results.Historically, the results from preclinical testing and early clinical trialsoften have not been predictive of results obtained in later clinical trials. Anumber of new drugs and therapeutics have shown promising results in initialclinical trials, but subsequently failed to establish 

 

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sufficient safety and effectiveness data to obtain necessary regulatoryapprovals. Data obtained from preclinical and clinical activities are subjectto varying interpretations, which may delay, limit or prevent regulatoryapproval.

 

**We are dependent on suppliers for the timelydelivery of materials and services and may experience in the future interruptionsin supply.**

 

For our STR product to be successful, we needsufficient, reliable and affordable supplies of the STR compound for clinicalstudies. This requires developing and maintaining reliable and affordablethird-party suppliers of commercial quantities of the radioactive substanceholmium-166, and the targeting agent DOTMP, used in our STR product candidate.Sources of these materials may be limited, and we, or potential third-partysuppliers of the STR compound, may be unable to obtain these materials inamounts and at prices necessary to successfully commercialize our STR product.Timely delivery of the holmium-166 component material and of the finished STRcompound is critical. For example, holmium-166 loses its effectiveness fortreating patients within a short period of time. As a result, the STR productmust be shipped within 24 hours of its manufacture to the site where thepatient is to be treated. Failures or delays in the manufacturing and shippingprocesses could compromise the quality and effectiveness of our product.

 

There are, in general, relatively few sourcesof the holmium-166 component of our STR product. Historically, we have dependedon a single source vendor, the University of Missouri Research Reactor facilitygroup (MURR) located in Columbia, Missouri. In March 2004, we entered into acontract, under which MURR is responsible for the manufacture, includingprocess qualification, quality control, packaging and shipping, of holmium-166for our phase III trial.  Our contractwith MURR is for an initial term of one year, which we may extend for up to twoadditional one-year periods.  OnNovember 4, 2004 we exercised the first renewel option to extend the termfor one additional year.  The contractmay be terminated by either party if the other party breaches the contract andsuch breach is not cured, if MURR fails to fulfill our purchase orders on atimely basis, or if any regulatory authority orders either party to stopmanufacturing or using holmium-166. Under the contract, we pay a fixed price per unit of holmium-166ordered, subject to certain minimum purchase requirements, and fixed amountsfor handling and maintenance.  While MURRgenerally has provided us materials with acceptable quality, quantity and costin the past, it may become unable or unwilling to meet our future demands, ordemands of potential third-party suppliers of our STR compound. If MURR or analternate supplier is unable or unwilling to provide supplies of holmium-166 ata cost and on other terms acceptable to us, the manufacture and delivery of ourSTR product candidate could be impaired, and we may suffer delays in, or beprevented from, initiating or completing further clinical trials of our STRproduct candidate.

 

We obtain DOTMP, the targeting agent for STR,from The Dow Chemical Company, from which we license the STR technology.Because we license the STR technology from Dow, we historically have not feltit necessary to enter into a formal supply agreement with Dow. We currentlyhave a sufficient supply of DOTMP on hand to complete our phase III studies.

 

In connection with our product developmentand manufacturing activities, we rely on third-party contractors to perform forus, or assist us with, certain specialized services, including process supportand equipment validation at the Denton facility, drug dispensing, distributionand shipping, and clinical trial management. We are not materially dependent onour relationship with any of these contractors. However, because thesecontractors provide specialized services, their activities and quality ofperformance may be outside our direct control. If these contractors do notperform their obligations in a timely manner, or if we encounter difficultieswith the quality of services we receive from these contractors, we may incuradditional costs and delays in our STR phase III trial and other productdevelopment activities, which could have a material negative effect on ourbusiness.

 

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

 

In connection with our 2001 purchase of theradiopharmaceutical manufacturing plant and other assets located in Denton, TX,we assumed $6,000,000 principal amount of restructured debt held by Texas StateBank, McAllen, TX.  The loan, whichmatures in April 2009, is secured by the assets acquired in thetransaction.  The interest rate on theloan was 4.75% on September 30, 2004. The interest rate is equal to the bank prime rate and adjusts as theprime rate changes.  The loan providesfor a maximum annual interest rate of 18%. Principal and interest are payable in monthly installments.  Principal and interest paid on the noteduring the third quarter of 2004 totaled $115,000.  In December 2003, we sold anon-essential portion of our Denton facility, the proceeds of which

 

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($827,000) were applied to reduce the outstanding balance on the loan.As of September 30, 2004, the outstanding balance of the loan was $4,270,000.The fixed monthly payments on the note are recalculated in April of each yearbased on the then current bank prime interest rate and outstanding notebalance. The bank prime interest rate of 4.00% was in effect on the paymentrecalculation date in April 2004, resulting in an estimated total fixed paymentobligation in 2004, reflecting both principal and interest, of $486,000.

 

During 2002 and early 2003, we reduced thestaff at the Denton facility to four employees and operated the facility instandby mode. In the second half of 2003, we re-staffed the facility inpreparation for resumption of manufacturing activities in the first quarter of2004. The terms of the Texas State Bank loan provide that an event of defaultmay be deemed to occur if we abandon, vacate or discontinue operations on asubstantial portion of the Denton facility or there is a material adversechange in our operations. We do not believe that operating the facility instandby mode during 2002 and early 2003 violated these provisions, nor hasTexas State Bank suggested that it views such activities as a potentialviolation. We can provide no assurance, however, that Texas State Bank will notsome time in the future seek to rely on these or other provisions of the loanto declare us in default of the loan. If this were to occur, Texas State Bankcould declare the entire outstanding amount of the loan ($4,270,000 atSeptember 30, 2004) due and immediately payable. In such case, our cash resourcesand assets could be impaired depending on our ability to raise funds through asale of the Denton facility and other means. Based on a November 2002appraisal of the Denton facility, the fair value of the facility and its assetsexceeds the amount of the outstanding debt.

 

**If we cannot negotiate and maintaincollaborative arrangements with third parties, our research, development,manufacturing, sales and marketing activities may not be cost-effective orsuccessful.**

 

Our success will depend in significant parton our ability to attract and maintain collaborative partners and relationshipsto support the development, sale, marketing, distribution and manufacture ofSTR, NX 473 and any other future product candidates in the US and Europe. Atpresent, we have two material collaborative agreements.  The first is the exclusive worldwide (exceptin Australia) license granted to us by The Dow Chemical Company for thedevelopment and commercial sale of STR. Under that license, we are solelyresponsible for the development and commercialization of STR. Dow retains theobligation, at its cost, to prosecute patent applications and maintain, extendand defend all patents. Dow is entitled to certain payments under the licenseif and when we receive final approval for commercial sale of STR in variousjurisdictions. After final approval, Dow will be entitled to certain royaltiesand milestone payments based on our annual net sales of STR and relatedproducts. If we are successful in achieving all milestones under the Dow agreement,our total milestone payments to Dow would be $8,500,000. We cannot be certainof the extent of our success, if any, in commercializing STR and attainingestablished milestones. The license agreement may be terminated by either partyfor breach. We can terminate the license at any time upon prior written noticeto Dow. Dow may terminate the license if we cease to carry on our business as aresult of liquidation, bankruptcy or insolvency. If not earlier terminated, thelicense agreement will continue in effect until expiration of all patentslicensed under the agreement. We currently anticipate such expiration date tobe February 3, 2015. Upon expiration of the Dow license agreement, we willretain from Dow a fully paid-up license to use unpatented technology related toSTR. If Dow were to breach its obligations under the license, or if the licenseexpires or is terminated and we cannot renew, replace, extend or preserve ourrights under the license agreement, our STR development efforts and our businesscould be significantly adversely affected.

 

Our second material collaborative agreementis the exclusive worldwide (except Japan) license granted to us by AnorMED,Inc. for the development and commercial sale of an anti-cancer platinumcompound, NX 473.  Under thatlicense, we are solely responsible for the development and commercialization ofNX 473. AnorMED retains the obligation, at its cost, to prosecute patentapplications and maintain, extend and defend 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 million, payable in cash or acombination of cash and NeoRx common stock. These milestones include oursuccessful completion of an NX 473 phase II study or initiation of anNX 473 phase III study, submission to the FDA of an NDA for NX 473,regulatory approval from the FDA of NX 473 and the attainment of certainlevels of annual net sales of NX 473. Upon regulatory approval, AnorMED also would receive royalty payments ofup to 15% on product sales.  We cannot becertain of the extent of our success, if any, in commercializing NX 473and attaining established milestones. The license agreement may be terminated by either party for breach, ifthe other party files a petition in bankruptcy or insolvency or forreorganization, or is dissolved, liquidated or makes assignment for the benefitof creditors. We can terminate the license at any time upon prior writtennotice to AnorMED. If not earlier terminated, the license agreement willcontinue in effect, in each country in the territory in which the licensedproduct is sold or manufactured, until the 

 

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earlier of (i) expiration of the last valid claim of a pending orissued patent covering the licensed product in that country or (ii) a specifiednumber of years after first commercial sale of the licensed product in thatcountry.  In October 2004, we filed anInvestigational New Drug (IND) application for NX 473 for a phase II study inlung cancer, which we currently plan to initiate in the first half of2005.  If AnorMED were to breach itsobligations under the license, or if the license expires or is terminated andwe cannot renew, replace, extend or preserve our rights under the licenseagreement, we would be unable to move forward with our plan to undertakeNX 473 clinical studies.

 

None of our current employees has anyexperience selling, marketing and distributing therapeutic products. To theextent we are successful in obtaining approval for the commercial sale of STRor any other product candidate, we may need to secure one or more corporatepartners to conduct these activities. We may not be able to enter intopartnering arrangements in a timely manner or on terms acceptable to us. To theextent that we enter into co-promotion or other licensing arrangements, ourproduct revenues are likely to be lower than if we directly marketed and soldour products, and any revenues we receive would depend upon the efforts ofthird parties, which efforts may not be successful. If we are not able tosecure adequate partnering arrangements, we would have to hire additionalemployees or consultants with expertise in sales, marketing and distribution.Employees with relevant skills may not be available to us. Additionally, anyincrease in the number of employees would increase our expense level and couldhave a material adverse effect on our financial position.

 

**Any delays in our STR manufacturingoperations in Denton, TX, or failure to operate the facility in acost-effective manner and in accordance with regulatory requirements, could adverselyaffect our ability to conduct our STR phase III trials on a timely andcost-effective basis.**

 

In April 2001, we purchased amanufacturing facility and certain other assets located in Denton, TX. Inaddition to the manufacturing facility, we purchased existing equipment,documentation and certain processes. The facility is operated in accordancewith current Good Manufacturing Practices (cGMP) and was issued appropriateradiation permits by the Texas Department of Health. This manufacturing facilityassumed responsibility for all aspects of the manufacture of the STR compound,including process qualification, quality control, packaging and shipping, andproduction of the clinical material for our completed STR dosimetry study. Webelieve that the Denton facility has the capabilities and capacity to serve asthe principal manufacturing site for the STR compound for our phase IIIclinical trial and for potential commercial manufacture.  We resumed our manufacturing activities atthe Denton facility in February 2004. Our ability to continue to utilize theDenton facility as our primary manufacturing site for the STR compound in thefuture will depend on a number of factors, including:

 

•    actions taken bythe FDA and the timing thereof;

 

•    our ability to obtainadequate additional funding and the timing thereof;

 

•    our ability toaccess sufficient, reliable and affordable third-party supplies of holmium-166;

 

•    the costs ofmaintaining manufacturing operations;

 

•    our ability toretain qualified personnel and necessary regulatory permits; and

 

•    the availabilityand cost of potential third-party suppliers of STR.

 

If, in the future, we decide to transitionthe STR production process to a third-party supplier, such third-party suppliercould require significant start-up time to qualify and implement themanufacturing process. In such case, our ability to move forward with furtherSTR clinical and commercial development could be adversely affected and we mayincur significant additional costs in connection with manufacturing operations.Further, there can be no assurance that manufacturing alternatives would beavailable on a timely or cost-effective basis.

 

We, or any potential third-partymanufacturers, must continuously adhere to cGMP regulations enforced by the FDAthrough its facilities inspection program. If our facilities or the facilitiesof these manufacturers cannot pass a pre-approval plant inspection, the FDAwill not grant an NDA for our proposed products. In complying with cGMP andforeign regulatory requirements, we and any of our third-party manufacturerswill be obligated to expend time, money and effort in production,record-keeping and quality control to assure that our products meet applicable 

 

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specifications and other requirements. If we, or any of our third-partymanufacturers, fail to comply with these requirements, we may be subject toregulatory action.

 

**We face substantial competition in thedevelopment of cancer therapies and may not be able to compete successfully,and our potential products may be rendered obsolete by rapid technologicalchange.**

 

Thecompetition for development of cancer therapies is intense. There are numerouscompetitors developing products to treat the diseases for which we are seekingto develop products. We initially are focusing clinical development of our STRproduct candidate on the treatment of multiple myeloma. Several companies,including Celgene Corp. and Millennium Pharmaceuticals, Inc., also aredeveloping and testing therapeutics for multiple myeloma. In May 2003Millennium obtained FDA approval for its Velcade® (bortezomib) therapeutic fortreatment of multiple myeloma patients who have received at least two priortherapies and demonstrated disease progression on the last therapy. Forexample, in September 2004 Millennium filed a supplemental New DrugApplication (sNDA) with the FDA for use of Velcade for the treatment ofpatients with multiple myeloma who have received at least one prior therapy.  In October 2004, Celgene received anapprovable letter from the FDA for a sNDA for Thalomid® (thalidomide) fortreatment of multiple myeloma.  The FDAletter stated that sufficient support for an accelerated approval could beprovided by the results of a completed large, randomized study comparingThalomid plus dexamethasone to dexamethasone alone in previously untreatedmultiple myeloma patients.  Thalomid isapproved for treatment of the cutaneous manifestations of moderate to severeerythema nodosum leprosum in leprosy.

 

In addition, a number of establishedpharmaceutical companies, including GlaxoSmithKline, Novartis AG andBristol-Myers Squibb Co., are developing proprietary technologies or haveenhanced their capabilities by entering into arrangements with, or acquiring,companies with technologies applicable to the treatment of cancer. Many of ourexisting or potential competitors have, or have access to, substantiallygreater financial, research and development, marketing and production resourcesthan we do and may be better equipped than we are to develop, manufacture andmarket competing products. Our competitors may have, or may develop andintroduce, new products that would render our technology and proposed STRproduct less competitive, uneconomical or obsolete.

 

We also expect to face increasing competitionfrom universities and other non-profit research organizations. Theseinstitutions, which carry out a significant amount of cancer research anddevelopment, are becoming increasingly aware of the commercial value of theirfindings and more active in seeking patent and other proprietary rights, aswell as licensing revenues.

 

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

 

Our success is dependent in part onobtaining, maintaining and enforcing our patents and other proprietary rightsand our ability to avoid infringing the proprietary rights of others. Patentlaw relating to the scope of claims in the biotechnology field in which we operateis still evolving and, consequently, patent positions in our industry may notbe as strong as in other, better-established fields. Accordingly, the UnitedStates Patent and Trademark Office (USPTO) may not issue patents from thepatent applications owned by or licensed to us. If issued, the patents may notgive us an advantage over competitors with similar technologies.

 

We own over 100 patents issued in the UnitedStates and in foreign jurisdictions and have licenses to additional patents.However, 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 otherresources, even if we were successful in stopping the violation of our patentrights. In addition, there is a risk that a court would decide that our patentsare not valid and 

 

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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 patentswere upheld, a court would refuse to stop the other party on the ground thatits activities do not infringe our patents.

 

In addition, the protection afforded byissued patents is limited in duration. With respect to our STR product indevelopment in the United States, we hold USPN 6,767,531 (expiring June 12,2020) directed to the STR product in development and have additional patentapplications pending in the United States and abroad.  We also rely on USPN 4,882,142 (expiringDecember 19, 2008) and USPN 5,059,412 (expiring October 22, 2008), bothof which are licensed to us by The Dow Chemical Company. We may be able to relyon the Hatch-Waxman Act to extend the term of a US patent covering STR afterregulatory approval of STR in the United States.

 

Under our license agreement with Dow, Dowretains the obligation, at its cost, to prosecute patent applications andmaintain, extend and defend all licensed patents. Dow has the first right tosue any third party infringers of the STR patents. If Dow does not file suit,we have the right to sue the infringer at our own expense.

 

In addition to the intellectual propertyrights described above, we rely on unpatented technology, trade secrets andconfidential information. Therefore, others may independently developsubstantially equivalent information and techniques or otherwise gain access toor disclose our technology. We may not be able to effectively protect ourrights in unpatented technology, trade secrets and confidential information. Werequire each of our employees, consultants and advisors to execute aconfidentiality agreement at the commencement of an employment or consultingrelationship with us. However, these agreements may not provide effectiveprotection of our information or, in the event of unauthorized use ordisclosure, they may not provide adequate remedies.

 

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

 

Our competitors or others may have or mayacquire patent rights that they could enforce against us. In such case, we maybe required to alter our products, pay licensing fees or cease activities. Ifour products conflict with patent rights of others, third parties could bringlegal actions against us claiming damages and seeking to enjoin manufacturingand marketing of the affected products. If these legal actions are successful,in addition to any potential liability for damages, we could be required toobtain a license in order to continue to manufacture or market the affectedproducts. We may not prevail in any legal action and a required license underthe patent may not be available on acceptable terms.

 

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

 

The cost to us of any litigation or otherproceedings relating to intellectual property rights, even if resolved in ourfavor, could be substantial. Some of our competitors may be better able tosustain the costs of complex patent litigation because they have substantiallygreater resources. If there is litigation against us, we may not be able tocontinue our operations. If third parties file patent applications, or areissued patents claiming technology also claimed by us in pending applications,we may be required to participate in interference proceedings in the USPTO todetermine priority of invention. We may be required to participate ininterference proceedings involving our issued patents and pending applications.We may be required to cease using the technology or license rights fromprevailing third parties as a result of an unfavorable outcome in an interferenceproceeding. A prevailing party in that case may not offer us a license oncommercially acceptable terms.

 

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

 

The testing, manufacturing, marketing andsale of STR and any other proposed cancer therapy products may subject us toproduct liability claims. We are insured against such risks up to a$10 million annual aggregate limit in connection with clinical trials ofour products under development and intend to obtain product liability coveragein the future. However, insurance coverage may not be available to us at anacceptable cost. We may not be able to obtain insurance coverage that will beadequate to satisfy any liability that may arise. Regardless of merit oreventual outcome, product liability claims may result in decreased demand for aproduct, injury to our reputation, withdrawal of clinical trial volunteers andloss of revenues. As a result, regardless of whether we are insured, a productliability claim or product recall may result in losses that could be material.

 

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

 

Our research and development andmanufacturing processes, as well as the manufacturing processes that may beused by our collaborators, involve the controlled use of hazardous andradioactive materials. As a result, we are subject to foreign, federal, stateand local laws, rules, regulations and policies governing the use, generation,manufacture, storage, air emission, effluent discharge, handling and disposal ofcertain materials and wastes in connection with our use of these materials.Although we believe that our safety procedures for handling and disposing ofsuch materials comply with the standards prescribed by such laws andregulations, we may be required to incur significant costs to comply withenvironmental and health and safety regulations in the future. In the eventthat we discontinue operations in facilities that have had past research andmanufacturing processes where hazardous or radioactive materials have been inuse, we may have significant decommissioning costs associated with thetermination of operation of these facilities. These potential decommissioningcosts also may reduce the market value of the facilities and may limit ourability to sell or otherwise dispose of these facilities in a timely andcost-effective manner. In addition, the risk of accidental contamination orinjury from hazardous or radioactive materials cannot be completely eliminated.In the event of such an accident, we could be held liable for any resultingdamages, and any such liability could exceed our resources. Our currentinsurance does not cover liability for the clean-up of hazardous wastematerials or other environmental risks.

 

**Even if we bring products to market, we maynot be able obtain adequate reimbursement for sales of our products which couldadversely affect our ability to effectively price our products.**

 

Potential sales of our products may beaffected by the availability of reimbursement from governments or other thirdparties, such as insurance companies. It is difficult to predict thereimbursement status of newly approved, novel medical products. In addition,third-party payors are increasingly challenging the prices charged for medicalproducts and services. If we succeed in bringing one or more products tomarket, we cannot be certain that these products will be consideredcost-effective and that reimbursement to the consumer will be available or willbe sufficient to allow us to competitively and profitably sell our products.

 

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

 

Since July 2002, we have implementedthree reductions in force. Also in January 2003, we accepted theresignations of Richard Ghalie, MD, Vice President, Medical and RegulatoryAffairs, and Les Sabo, Vice President, Manufacturing. Jack L. Bowman was namedExecutive Chairman and became Chairman of our Board of Directors onMarch 11, 2003. Douglass B. Given, MD, PhD, resigned as President, ChiefExecutive Officer and a Director of the Company on September 30, 2003. On thatdate, Mr. Bowman was named Chief Executive Officer and KarenAuditore-Hargreaves, PhD, was promoted to Chief Operating Officer of theCompany. Dr. Auditore-Hargreaves was elected President of the Companyeffective December 5, 2003. Neile Grayson, PhD, resigned as VicePresident, Corporate Development, in January 2004. Although Mr. Saboand Drs. Given and Grayson were officers of the Company, we did not, at the timeof their resignations, consider them key employees in terms of our STR productdevelopment activities or other programs. Dr. Ghalie, as Vice President,Medical and Regulatory Affairs, was considered a key employee of the Company.We did not experience any material disruptions or delays as a consequence ofthe resignations of any or all of Mr. Sabo and Drs. Grayson, Given orGhalie. Dr. Given and Mr. Sabo have been replaced. Dr. Grayson’sposition has been eliminated and her responsibilities reassigned to othermembers of management. Dr. Ghalie’s position currently is vacant, and weare actively seeking a replacement. We 

 

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elected to delay recruiting a replacement for Dr. Ghalie until theFDA-imposed clinical hold on STR was lifted. In the interim, medical and otherprofessional employees of the Company and outside consultants have performed,and will continue to perform, the administrative and managerialresponsibilities previously assigned to Dr. Ghalie.  Melinda G. Kile resigned as Vice President,Finance, effective April 16, 2004.  Onthat date, Michael K. Jackson was promoted to Chief Accounting Officer andassumed responsibility for senior financial duties on an interim basis.  Susan D. Berland was appointed Chief FinancialOfficer effective October 25, 2004.  Wedid not experience any material disruptions or delays as a consequence of Ms.Kile’s resignation.

 

Jerry McMahon, Ph.D. was appointed ChiefExecutive Officer of the Company, effective May 11, 2004, and was namedChairman of the Board of Directors in June 2004.  Mr. Bowman retired from his position as ChiefExecutive Officer effective May 11, 2004, and he did not stand for reelectionas a director of the Company at the Company’s Annual Meeting of Shareholders heldon May 18, 2004.  Mr. Bowman wasconsidered a key employee of the Company. We did not experience any material disruption or delays as a consequenceof Mr. Bowman’s retirement.

 

As of September 30, 2004, we had a total workforce of 40 full-time employees and three part-time employees. Our successdepends, to a significant extent, on the continued contributions of ourprincipal management, scientific, and manufacturing personnel. We have limitedor no redundancy of personnel in several key development areas includingclinical operations, regulatory affairs, quality control and assurance andmanufacturing. The loss of the services of one or more of our employees coulddelay our STR and NX 473 product development activities or other programs andresearch and development efforts. We do not maintain key-person life insuranceon any of our officers, employees or consultants.

 

Competition for qualified employees amongcompanies in the biotechnology and biopharmaceutical industry is intense. Ourfuture success depends upon our ability to attract, retain and motivate highlyskilled employees and consultants. In order to commercialize our proposedproducts successfully, we will in the future be required to expandsubstantially our workforce, particularly in the areas of manufacturing,clinical trials management, regulatory affairs, business development and salesand marketing. These activities will require the addition of new personnel,including management, and the development of additional expertise by existing managementpersonnel. Our current financial situation may make it more difficult toattract and retain key employees.

 

We have change in control agreements andseverance agreements with all of our executive officers and consultingagreements with various of our scientific advisors. Our agreements with ourexecutive officers provide for “at will” employment, which means that eachexecutive may terminate his or her service with us at any time. In addition,our scientific advisors may terminate their services to us at any time. As ofthe date of this report, no current key employee has announced his or herintention to leave the company.

 

**Any weakness identified in our internalcontrols over financial reporting as part of the evaluation being undertaken byus and our independent public accountants pursuant to Section 404 of theSarbanes-Oxley Act of 2002 could have an adverse effect on our business.**

 

Section 404 of the Sarbanes-Oxley Act of 2002requires that public companies evaluate and report on their systems of internalcontrol over financial reporting. In addition, the independent accountants mustreport on management’s evaluation. We are in the process of documenting andtesting our system of internal control over financial reporting to provide thebasis for our report. We have retained consultants to help us with this processand are working with our auditors as appropriate.  We cannot be certain as to the timing ofcompletion of our evaluation and related actions, or the impact of any of themon our operations or stock price.  Uponthe completion of our review, it is possible that certain deficiencies could bediscovered that will require remediation. Due to the ongoing evaluation andtesting of our internal controls, we cannot assure you that there will not beany significant deficiencies or material weaknesses that would be required tobe reported. In addition, we expect the evaluation process and any requiredremediation, if applicable, to increase our accounting, legal and other costsand divert management resources from core business operations.

 

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**Risks Related to Our Common Stock**

 

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

 

Our common stock listing was transferred fromThe Nasdaq National Market to The Nasdaq SmallCap Market on March 20,2003. We elected to seek a transfer to The Nasdaq SmallCap Market because wehad been unable to regain compliance with The Nasdaq National Market minimum$1.00 bid price requirement for continued listing. By transferring to TheSmallCap Market, we were afforded an extended grace period in which to satisfyThe SmallCap Market $1.00 minimum bid price requirement. On May 6, 2003,we received notice from Nasdaq confirming that we are in compliance with the$1.00 SmallCap minimum bid price requirement. As a result of rule changesadopted by Nasdaq in March 2003, we will not be eligible to relist ourcommon stock on The Nasdaq National Market unless and until our common stockmaintains a minimum bid price of $5.00 per share for 90 consecutive tradingdays and we otherwise comply with the initial listing requirements for The NasdaqNational Market. Trading on The Nasdaq SmallCap Market may have a negativeimpact on the value of our common stock, because securities trading on TheNasdaq SmallCap Market typically are less liquid than those traded on TheNasdaq National Market.

 

If our common stock is delisted from TheNasdaq SmallCap Market, we would likely seek quotation on the American StockExchange or a regional stock exchange, if available. Such listing could reducethe market liquidity for our common stock. If our common stock is not quoted onanother market or exchange, trading of our common stock could be conducted inthe over-the-counter market on an electronic bulletin board established forunlisted securities such as the Pink Sheets or the OTC Bulletin Board. As aresult, an investor would find it more difficult to dispose of, or obtainaccurate quotations for the price of, our common stock.

 

If our common stock is delisted from TheNasdaq SmallCap Market, and if we fail to obtain quotation on another market orexchange, and if the trading price remains below $5.00 per share, then tradingin our common stock might also become subject to the requirements of certainrules promulgated under the Securities Exchange Act of 1934, which requireadditional disclosure by broker-dealers in connection with any trade involvinga stock defined as a “penny stock” (generally, any equity security not listedon a national securities exchange or quoted on Nasdaq that has a market priceof less than $5.00 per share, subject to certain exceptions). Many brokeragefirms are reluctant to recommend low-priced stocks to their clients. Moreover,various regulations and policies restrict the ability of shareholders to borrowagainst or “margin” low-priced stocks, and declines in the stock price belowcertain levels may trigger unexpected margin calls. Additionally, becausebrokers’ commissions on low-priced stocks generally represent a higherpercentage of the stock price than commissions on higher priced stocks, thecurrent price of the common stock can result in an individual shareholderpaying transaction costs that represent a higher percentage of total sharevalue than would be the case if our share price were higher. This factor mayalso limit the willingness of institutions to purchase our common stock.Finally, the additional burdens imposed upon broker-dealers by theserequirements could discourage broker-dealers from facilitating trades in ourcommon stock, which could severely limit the market liquidity of the stock andthe ability of investors to trade our common stock.

 

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

 

There has been a history of significantvolatility in the market prices of securities of biotechnology companies,including our common stock. The high and low closing sale prices for our commonstock were $6.05 and $0.28 in 2002. In 2003, the high and low closing saleprices were $6.47 and $0.37. The high and low closing sale prices during theperiod from January 2, 2004 through November 1, 2004 were $5.78 and $1.43.Our stock price has been and may continue to be affected by this type of marketvolatility, as well as our own performance. Our business and the relative priceof our common stock may be influenced by a large variety of factors, including:

 

•    announcements byus or our competitors concerning acquisitions, strategic alliances,technological innovations and new commercial products;

 

•    the availabilityof critical materials used in developing and manufacturing STR and other productcandidates;

 

•    the progress andresults of clinical trials;

 

•    developmentsconcerning patents, proprietary rights and potential infringement;

 

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

 

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approvals; and

 

•    our availablecash.

 

In addition, potential public concern aboutthe safety of our proposed STR product and any other products we develop,comments by securities analysts, our ability to maintain the listing of ourcommon stock on the Nasdaq system, and conditions in the capital markets ingeneral and in the life science capital market specifically, may have asignificant effect on the market price of our common stock. The realization ofany of the risks described in this report, as well as other factors, could havea material adverse impact on the market price of our common stock and mayresult in a loss of some or all of your investment in NeoRx.

 

In the past, securities class actionlitigation often has been brought against companies following periods ofvolatility in their stock prices. We may in the future be the target of similarlitigation. Securities litigation could result in substantial costs and divertour management’s time and resources, which could cause our business to suffer.

 

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

 

Our articles of incorporation authorize ourboard of directors to issue up to 3,000,000 shares of preferred stock and todetermine the price, rights, preference, privileges and restrictions, includingvoting rights, of those shares without any further vote or action by ourshareholders.

 

We have adopted a shareholder rights plan,which is intended to protect the rights of shareholders by deterring coerciveor unfair takeover tactics. The board of directors declared a dividend toholders of our common stock of one preferred share purchase right for eachoutstanding share of common stock. In addition, under certain circumstances,holders of our Series B Convertible Preferred Stock are entitled toreceive one preferred share purchase right for each share of common stock intowhich their Series B preferred stock may be converted. The rights areexercisable ten days following the offer to purchase or acquisition ofbeneficial ownership of 20% of the outstanding common stock by a person orgroup of affiliated persons. Each right entitles the registered holder, otherthan the acquiring person or group, to purchase from NeoRx one-hundredth of oneshare of Series A Junior Participating Preferred Stock at the price of$40, subject to adjustment. The rights expire April 10, 2006. In lieu ofexercising the right by purchasing one one-hundredth of one share of Series Apreferred stock, the holder of the right, other than the acquiring person orgroup, may purchase for $40 that number of shares of our common stock having amarket value of twice that price.

 

Washington law imposes restrictions oncertain transactions between a corporation and significant shareholders.Chapter 23B.19 of the Washington Business Corporation Act prohibits a targetcorporation, with some exceptions, from engaging in particular significantbusiness transactions with an acquiring person, which is defined as a person orgroup of persons that beneficially owns 10% or more of the voting securities ofthe target corporation, for a period of five years after the acquisition,unless the transaction or acquisition of shares is approved by a majority ofthe members of the target corporation’s board of directors prior to theacquisition. Prohibited transactions include, among other things:

 

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

 

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

 

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

 

A corporation may not opt out of thisstatute. This provision may have the effect of delaying, deterring orpreventing a change in control of NeoRx or limiting future investment in NeoRxby significant shareholders and their affiliates and associates.

 

The provisions of our articles ofincorporation, shareholder rights plan and Washington law discussed above mayhave the effect of delaying, deterring or preventing a change of control ofNeoRx, even if this change would be beneficial to our shareholders. Theseprovisions also may discourage bids for our common stock at a premium over marketprice and may adversely affect the market price of, and the voting and otherrights of the

 

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holders of, our common stock. In addition, these provisions could makeit more difficult to replace or remove our current directors and management inthe event our shareholders believe this would be in the best interests of thecorporation and our shareholders.

 

**Certain provisions of our Series BConvertible Preferred Stock and certain outstanding warrants may prevent ormake it more difficult for us to raise funds or take other actions.**

 

Certain provisions of the Preferred Stock andWarrant Purchase Agreement and Certificate of Designation for our Series BConvertible Preferred Stock may require us to obtain the approval of theholders of Series B preferred stock to amend, alter or repeal anyprovision of the Certificate of Designation which may be deemed to materiallyadversely affect the rights of the holders of Series B preferred stock orto authorize, create or issue any class or series of securities havingliquidation or other rights superior to those of the Series B preferredstock. The Series B preferred stock also contains provisions requiring theadjustment of the conversion price and the number of issuable common shares ifwe issue (other than in connection with certain permitted transactions, such asstrategic collaborations and acquisitions approved by the board of directors ortransactions approved by a majority of the holders of the Series B preferredstock) shares of common stock at prices lower than the then current conversionprice of the Series B preferred stock. Warrants issued to investors in ourFebruary 2004 common stock financing (the “2004 Financing”) contain similarantidilution provisions.  This means thatif we need to raise equity financing at any time when the prevailing ordiscounted market price for our common stock is lower than the conversion priceof the Series B preferred stock and/or the exercise price of the warrants, theconversion price and/or exercise price and number of shares issuable uponconversion or exercise will be adjusted and the dilution to shareholdersincreased. These provisions may make it more difficult for our management orshareholders to take certain corporate actions and could delay, discourage orprevent future financings. These provisions could also limit the price thatcertain investors might be willing to pay for shares of our common stock.

 

The outstanding shares of Series Bpreferred stock, at a conversion price of $5.00 per share, are currentlyconvertible into 3,150,000 shares of common stock. In addition, warrantsaccompanying the Series B preferred stock, at an exercise price of $6.00per share, are exercisable for 630,000 shares of common stock. These shares ofcommon stock, when issued upon conversion of the Series B preferred stockand exercise of the warrants, have been registered with the SEC and aregenerally available for immediate resale in the public market.  We issued in the 2004 Financing 1,845,000shares of common stock and warrants, at an exercise price of $7.00 per share,exercisable into 922,500 shares of common stock. The shares of common stockissued in the 2004 Financing, and the shares of common stock issuable uponexercise of the warrants related thereto, have been registered with the SEC andare generally available for immediate resale in the public market.  The market price of our common stock couldfall as a result of such resales due to the increased number of sharesavailable for sale in the market.

 

**Item 3.  Quantitative andQualitative Disclosures about Market Risk**

 

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

 

**Interest Rate Risk**

 

The Company’s exposure to market rate riskfor changes in interest rates relates primarily to the Company’s debtsecurities included in its investment portfolio.  The Company does not have any derivativefinancial instruments.  The Companyinvests in debt instruments of the US Government and its agencies andhigh-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 a rise in interest rates, while floatingrate securities may produce less income than expected if interest ratesdecrease.  Due in part to these factors,the Company’s future investment income may fall short of expectations due tochanges in interest rates or the Company may suffer losses in principal ifforced to sell securities that have declined in market value due to changes ininterest rates.  At September 30, 2004,the Company owned government debt instruments totaling $1.5 million and ownedno corporate debt securities. The Company’s exposure to losses as a result ofinterest rate changes is managed through investing primarily in securities withrelatively short maturities of up to three years and securities with variableinterest rates.  The Company’s debtsecurities as of September 30, 2004 had maturities of less then one year.

 

The Company’s only outstanding debt is itsnote payable to Texas State Bank.  Theoutstanding balance of 

 

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the note was $4,270,000 on September 30, 2004.  The note, which matures in April 2009, bearsinterest equal to the bank prime rate. The interest rate on the note is adjusted on the same date that the bankprime rate changes.  The maximumpermitted interest rate on the loan is 18% per annum. Because the interest rateon the note varies, the Company’s interest expenses may increase as the bankprime interest rate increases.  Extremeincreases in the bank prime interest rate, up to the maximum interest ratepermitted under the note, could materially affect the Company’s interestexpense.

 

**Item 4. Controls and Procedures**

** **

Under the supervision and with theparticipation of the Company’s management, including the Company’s Chairman andChief Executive Officer and the Chief Financial Officer, the Company hasevaluated the effectiveness and design and operation of its disclosure controlsand procedures as of the end of the quarter and, based on their evaluation, theChairman and Chief Executive Officer and the Chief Financial Officer haveconcluded that these disclosure controls and procedures are effective inensuring that the information disclosed by the Company in the reports that itfiles or submits under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified in SECrules and forms.

 

There were no changes in the Company’sinternal controls over financial reporting that occurred during the quarterthat have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting.

 

*Limitations on the Effectivness of Controls*

Our management, including our Chairman and Chief Executive Officer andour Chief Financial Officer, does not expect that our disclosure controls orour internal controls will prevent all error and all fraud.  A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of that control system are met.  Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrol must be considered relative to their costs. Because of the inherentlimitation in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within the Company have been detected. These inherent limitations include the reality that judgments indecision-making can be faulty, and breakdowns can occur because of simple erroror mistake.  Additionally, controls canbe circumvented by the individual acts of some persons, by collusion of two ormore persions, or by management override of the control.  The design of any system of controls is alsobased in part upon certain assumptions about the likelihood of future events,and there can be no assurance that any design will succeed in achieving itsstated goals under all potential future conditions; over time controls maybecome inadequate because of changes in conditions, of the degree of compliancewith the policies and procedures may deteriorate.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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**PARTII.  OTHER INFORMATION**

 

**Item 6.  Exhibits**

 

Exhibits – See Exhibit Index below.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                   | NEORX CORPORATION       |                 |
|------------------------|-------------------------|----------------------|
|                   | (Registrant)            |                 |
|                   |                    |                 |
| Date: November 9, 2004 | By:                     | /s/ SUSAN D. BERLAND |   |   |
|                   | Susan D. Berland        |                 |
|                   | Chief Financial Officer |                 |
|                        |                         |                      |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                         | ** ** | ** ** |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 3.1         |       | Restated  Articles of Incorporation, as amended                                                                                                                                                                                         |       | (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        |       | Stock  Option Agreement, dated July 30, 2001, between NeoRx Corporation and Douglass  B. Given (‡)                                                                                                                                 |       | (G)        |
| 10.7        |       | Indemnification  Agreement (‡)                                                                                                                                                                                                     |       | (H)        |
| 10.8        |       | License  Agreement, dated June 30, 1999, between NeoRx and The Dow Chemical  Company.  Certain portions of the  agreement have been omitted pursuant to a grant of confidential treatment                                          |       | (K)        |
| 10.9        |       | Stock  Option Agreement, dated December 19, 2000, between NeoRx Corporation and Carl  S. Goldfischer (‡)                                                                                                                           |       | (I)        |
| 10.10       |       | Stock  Option Agreement, dated January 17, 2001, between NeoRx Corporation and Carl  S. Goldfischer  (‡)                                                                                                                      |       | (I)        |
| 10.11       |       | [Reserved]                                                                                                                                                                                                                              |       |       |
| 10.12       |       | Sublicense  Agreement, dated May 15, 1997, between NeoRx Corporation and Roche Molecular  Biochemicals.  Certain portions of the  agreement have been omitted pursuant to a grant of confidential treatment.                       |       | (L)        |
| 10.13       |       | Stock  Option Grant Program for Nonemployee Directors under the NeoRx Corporation  1994 Restated Stock Option Plan (‡)                                                                                                             |       | (M)        |
| 10.14       |       | Facilities  Lease, dated February 15, 2002, between NeoRx Corporation and Selig Real  Estate Holdings Six                                                                                                                               |       | (A)        |
| 10.15       |       | Lease  Termination/Continuation Agreement dated October 8, 2002, between NeoRx Corporation  and Dina Corporation                                                                                                                        |       | (N)        |
| 10.16       |       | Key  Executive Severance Agreement dated as of May 13, 2003, between the Company  and Karen Auditore-Hargreaves (‡)                                                                                                                |       | (C)        |
| 10.17       |       | Change  of Control Agreement dated as of May 13, 2003, between the Company and Karen  Auditore-Hargreaves (‡)                                                                                                                      |       | (C)        |
| 10.18       |       | Key  Executive Severance Agreement dated as of February 28, 2003, between the  Company and Linda Findlay (‡)                                                                                                                       |       | (C)        |
| 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       |       | 2004  Incentive Compensation Plan (‡)                                                                                                                                                                                              |       | (P)        |
| 10.22       |       | Supply  Agreement dated as of March 1, 2004, between  the Company and the University of Missouri Research Reactor facility group. Certain portions of the  agreement have been omitted pursuant to a request for confidential treatment |       | (Q)        |
| 10.23       |       | 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)        |
| 10.24       |       | Agreement  of Sale and Purchase dated as of April 2, 2004, between the Company and  Aletheon Pharmaceuticals, Inc.  Certain portions of the agreement have been omitted pursuant to a  request for confidential treatment          |       | (Q)        |
| 10.25       |       | Key  Executive Severance Agreement dated as of May 11, 2004, between the Company  and Jerry McMahon (‡)                                                                                                                            |       | (R)        |
| 10.26       |       | Change  of Control Agreement dated as of May 11, 2004, between the Company and Jerry  McMahon (‡)                                                                                                                                  |       | (R)        |
| 10.27       |       | Key  Executive Severance Agreement dated as of October 25, 2004, between the  Company and Susan D. Berland (‡)                                                                                                                     |       | (S)        |

 

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| 10.28 |   | Change  of Control Agreement dated as of October 25, 2004, between the Company and  Susan D. Berland (‡) |   | (S) |
|-------|--------|---------------------------------------------------------------------------------------------------------------|--------|-----|
| 10.29 |   | Form  of Non-Qualified Stock Option Agreement under 2004 Incentive Compensation  Plan                         |   | (O) |
| 10.30 |   | Form  of Incentive Stock Option Agreement under 2004 Incentive Compensation Plan                              |   | (O) |
| 31.1  |   | Rule  13a-14(a)/15d-14(a) Certification of Chairman and Chief Executive Officer                               |   | (O) |
| 31.2  |   | Rule  13a-14(a)/15d-14(a) Certification of Chief Financial Officer                                            |   | (O) |
| 32.1  |   | Section  1350 Certification of Chairman and Chief Executive Officer                                           |   | (O) |
| 32.2  |   | Section  1350 Certification of Chief Financial Officer                                                        |   | (O) |

 

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(‡)           Managementcontract or compensatory plan.

 

(A)          Filed as anexhibit to the Company’s Form 10-K for the fiscal year ended December 31, 2001,and incorporated herein by reference.

 

(B)           Filed as anexhibit to the Company’s Registration Statement on Form S-3 (No. 333-111344)filed on December 19, 2002, and incorporated herein by reference.

 

(C)           Filed as anexhibit to the Company’s Registration Statement on Form S-3/-A (RegistrationNo. 333-111344) filed on February 23, 2004, and incorporated herein byreference.

 

(D)          Filed as anexhibit to the Company’s Annual Report on Form 10-K for the fiscal year endedSeptember 30, 1991, and incorporated herein by reference.

 

(E)           Filed as anexhibit to the Company’s Registration Statement on Form S-2 (Registration No.33-71164) effective December 13, 1993, and incorporated herein by reference.

 

(F)           Filed as anexhibit to the Company’s Form 10-K for the fiscal year ended December 31, 1995,and incorporated herein by reference.

 

(G)           Filed as anexhibit to the Company’s Registration Statement on Form S-8 (Registration No.333-71368), filed October 10, 2001, and incorporated herein by reference.

 

(H)          Filed as anexhibit to the Company’s Form 10-Q for the quarterly period ended March 31,1996, and incorporated herein by reference.

 

(I)            Filed as anexhibit to the Company’s Form 10-K for the fiscal year ended December 31, 2000and incorporated herein by reference.

 

(J)            Filed as anexhibit to the Company’s Form 10-K for the fiscal year ended December 31, 1998,and incorporated herein by reference.

 

(K)          Filed as anexhibit to the Company’s Form 10-Q for the quarterly period ended September 30,1999, and incorporated herein by reference.

 

(L)           Filed as anexhibit to the Company’s Form 10-Q for the quarterly period ended March 31,2001, and incorporated herein by reference.

 

(M)         Filed as anexhibit to the Company’s Form 10-Q for the quarterly period ended June 30,2002, and incorporated herein by reference.

 

(N)          Filed as anexhibit to the Company’s Form 10-Q for the quarterly period ended September 30,2002, and incorporated herein by reference.

 

(O)          Submittedherewith.

 

(P)           Filed as anexhibit to the Company’s Registration Statement on Form S-8 (Registration No.333-115729), filed May 21, 2004, and incorporated herein by reference.

 

(Q)          Filed as anexhibit to the Company’s Form 10-Q for the quarterly period ended March 31,2004, and incorporated herein by reference.

 

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(R)           Filed as anexhibit to the Company’s Form 10-Q for the quarterly period ended June 30,2004, and incorporated herein by reference.

 

(S)           Filed as anexhibit to the Company’s Form 8-K filed October 19, 2004, and incorporatedherein by reference.

 

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