**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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

 

**For the quarterly period endedJune 30, 2004**

 

**Commission File No. 0-16614**

 

**NEORX CORPORATION**

(Exact name ofRegistrant as specified in its charter)

 

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

** **

**300 Elliott Avenue West, Suite 500, Seattle,Washington 98119-4114**

(Address of principalexecutive offices)

 

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

 

Indicateby check mark whether the Registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes      ý      No      o

 

Indicateby check mark whether the Registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act.

 

Yes      ý      No      o

 

Asof August 3, 2004, 30,397,135 shares of the Registrant’s common stock, $.02 parvalue per share, were outstanding.

 

 

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**TABLE OF CONTENTS**

 

**QUARTERLY REPORT ON FORM 10-QFOR THE QUARTER ENDED JUNE 30, 2004**

 
| **PART I**  | **FINANCIAL INFORMATION**                                                                                  | ** ** |
|-------------|------------------------------------------------------------------------------------------------------------|------------|
| ** **  | ** **                                                                                                 | ** ** |
| Item 1.     | Financial Statements (Unaudited):                                                                          |       |
|        |                                                                                                       |       |
|        | Condensed Consolidated Balance Sheets as of  June 30, 2004 and December 31, 2003                           |       |
|        |                                                                                                       |       |
|        | Condensed Consolidated Statements of  Operations for the Three and Six Months Ended June 30, 2004 and 2003 |       |
|        |                                                                                                       |       |
|        | Condensed Consolidated Statements of Cash  Flows for the Six Months Ended June 30, 2004 and 2003           |       |
|        |                                                                                                       |       |
|        | Notes to Condensed Consolidated Financial  Statements                                                      |       |
|        |                                                                                                       |       |
| Item 2.     | Management’s  Discussion and Analysis of Results of Operations and Financial Condition                |       |
|        |                                                                                                       |       |
| Item 3.     | Quantitative and Qualitative  Disclosures About Market Risk                                                |       |
|        |                                                                                                       |       |
| Item 4.     | Controls and Procedures                                                                                    |       |
|        | ** **                                                                                                 | ** ** |
| **PART II** | **OTHER INFORMATION**                                                                                      | ** ** |
| ** **  | ** **                                                                                                 | ** ** |
| Item 2.     | Changes in Securities and Use of Proceeds                                                                  |       |
|        |                                                                                                       |       |
| Item 4.     | Submission of Matters to a Vote of Security  Holders                                                       |       |
|        |                                                                                                       |       |
| Item 6.     | Exhibits and Reports on Form 8-K                                                                           |       |
|        |                                                                                                       |       |
|        | Signatures                                                                                                 |       |
|        |                                                                                                       |       |
|        | Exhibit  Index                                                                                             |       |

 

2

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**PARTI**.  FINANCIALINFORMATION

** **

**Item 1.** Financial Statements

** **

**NEORX CORPORATION AND SUBSIDIARY**

** **

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(in thousands,except share data)

(unaudited)

 
| ** **                                                                                                                                                                  | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **ASSETS**                                                                                                                                                                  |       |              |       |                  |       |
| ** **                                                                                                                                                                  |       |              |       |                  |       |
| **Current assets:**                                                                                                                                                         |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                   |       | $                 | 22,548     |                  | $          | 15,166 |   |
| Investment securities                                                                                                                                                       |       | 4,668             |       | 12,335                |       |
| Prepaid expenses and other current assets                                                                                                                                   |       | 210               |       | 652                   |       |
| Total current assets                                                                                                                                                        |       | 27,426            |       | 28,153                |       |
|                                                                                                                                                                        |       |              |       |                  |       |
| Facilities and equipment, net                                                                                                                                               |       | 7,295             |       | 7,471                 |       |
| Other assets, net                                                                                                                                                           |       | 67                |       | 67                    |       |
| Licensed products, net                                                                                                                                                      |       | 1,958             |       | —                |       |
|                                                                                                                                                                        |       |              |       |                  |       |
| **Total assets**                                                                                                                                                            |       | $                 | 36,746     |                  | $          | 35,691 |   |
| ** **                                                                                                                                                                  |       |              |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                               |       |              |       |                  |       |
| ** **                                                                                                                                                                  |       |              |       |                  |       |
| **Current liabilities:**                                                                                                                                                    |       |              |       |                  |       |
| Accounts payable                                                                                                                                                            |       | $                 | 374        |                  | $          | 409 |   |
| Accrued liabilities                                                                                                                                                         |       | 1,557             |       | 1,295                 |       |
| Current portion of note payable                                                                                                                                             |       | 283               |       | 385                   |       |
| Total current liabilities                                                                                                                                                   |       | 2,214             |       | 2,089                 |       |
|                                                                                                                                                                        |       |              |       |                  |       |
| **Long-term liabilities:**                                                                                                                                                  |       |              |       |                  |       |
| Note payable, net of current portion                                                                                                                                        |       | 4,051             |       | 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 June 30, 2004 and December  31, 2003 (entitled in liquidation to $5,175)                   |       | 4                 |       | 4                     |       |
| Convertible preferred stock,  Series B, 1,575 shares issued and outstanding at June 30, 2004 and December  31, 2003 (entitled in liquidation to $15,750)                    |       | —            |       | —                |       |
| Common stock, $.02 par value,  60,000,000 shares authorized, 30,388,010 and 28,002,945 shares  issued and outstanding at June 30,  2004 and December 31, 2003, respectively |       | 608               |       | 560                   |       |
| Additional paid-in capital                                                                                                                                                  |       | 254,071           |       | 243,365               |       |
| Accumulated deficit, including other  comprehensive loss of $8 and $7 at June 30, 2004 and December 31, 2003, respectively                                                  |       | (224,202          | )          | (214,439              | )          |
| Total shareholders’ equity                                                                                                                                             |       | 30,481            |       | 29,490                |       |
| **Total liabilities and shareholders’ equity**                                                                                                                         |       | $                 | 36,746     |                  | $          | 35,691 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

3

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**NEORX CORPORATION AND SUBSIDIARY**

 

**CONDENSEDCONSOLIDATEDSTATEMENTS OF OPERATIONS**

(inthousands, except per share data)

(unaudited)

 
| ** **                                                                    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **2004**                                                                      | ** ** | **2003**                        | ** ** | **2004**                      | ** ** | **2003** | ** ** |
|                                                                          |       |                            |       |                          |       |   |   |   |   |
| **Revenues**                                                                  |       | $                               | 508        |                          | $          | 10,190 |   | $ | 1,008 |   | $ | 10,306 |   |
| **Operating expenses:**                                                       |       |                            |       |                          |       |   |   |   |   |
| Research and development                                                      |       | 3,109                           |       | 2,728                         |       | 6,891 |   | 5,339 |   |
| General and administrative                                                    |       | 2,004                           |       | 2,168                         |       | 3,681 |   | 3,600 |   |
| Total operating expenses                                                      |       | 5,113                           |       | 4,896                         |       | 10,572 |   | 8,939 |   |
| Income (loss) from operations                                                 |       | (4,605                          | )          | 5,294                         |       | (9,564 | ) | 1,367 |   |
| **Other income (expense):**                                                   |       |                            |       |                          |       |   |   |   |   |
| Gain on disposal of equipment                                                 |       | —                          |       | 10                            |       | — |   | — |   |
| Interest income                                                               |       | 73                              |       | 83                            |       | 149 |   | 153 |   |
| Interest expense                                                              |       | (50                             | )          | (59                           | )          | (97 | ) | (119 | ) |
| Total other income                                                            |       | 23                              |       | 34                            |       | 52 |   | 34 |   |
| Net income (loss) before cumulative effect  of change in accounting principle |       | (4,582                          | )          | 5,328                         |       | (9,512 | ) | 1,401 |   |
| Cumulative effect of change in accounting  principle                          |       | —                          |       | —                        |       | — |   | 190 |   |
| Net income (loss)                                                             |       | (4,582                          | )          | 5,328                         |       | (9,512 | ) | 1,211 |   |
| Preferred stock dividends                                                     |       | (125                            | )          | (125                          | )          | (250 | ) | (250 | ) |
| Net income (loss) applicable to common  shares                                |       | $                               | (4,707     | )                             | $          | 5,203 |   | $ | (9,762 | ) | $ | 961 |   |
|                                                                          |       |                            |       |                          |       |   |   |   |   |
| Earnings (loss) per share applicable to  common shares:                       |       |                            |       |                          |       |   |   |   |   |
| Basic:                                                                        |       |                            |       |                          |       |   |   |   |   |
| Before cumulative effect of change in  accounting principle                   |       | $                               | (0.16      | )                             | $          | 0.19 |   | $ | (0.33 | ) | $ | 0.04 |   |
| Cumulative effect of change in accounting  principle                          |       | —                          |       | —                        |       | — |   | — |   |
| Income (loss) applicable to common shares                                     |       | $                               | (0.16      | )                             | $          | 0.19 |   | $ | (0.33 | ) | $ | 0.04 |   |
|                                                                          |       |                            |       |                          |       |   |   |   |   |
| Diluted:                                                                      |       |                            |       |                          |       |   |   |   |   |
| Before cumulative effect of change in  accounting principle                   |       | $                               | (0.16      | )                             | $          | 0.18 |   | $ | (0.33 | ) | $ | 0.04 |   |
| Cumulative effect of change in accounting  principle                          |       | —                          |       | —                        |       | — |   | (0.01 | ) |
| Income (loss) applicable to common shares                                     |       | $                               | (0.16      | )                             | $          | 0 .18 |   | $ | (0.33 | ) | $ | 0.03 |   |
|                                                                          |       |                            |       |                          |       |   |   |   |   |
| Shares used in calculation of loss per  share:                                |       |                            |       |                          |       |   |   |   |   |
| Basic                                                                         |       | 30,358                          |       | 27,009                        |       | 29,639 |   | 26,913 |   |
| Diluted                                                                       |       | 30,358                          |       | 28,420                        |       | 29,639 |   | 27,777 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

4

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**NEORX CORPORATION AND SUBSIDIARY**

 

**CONDENSEDCONSOLIDATED STATEMENTS OFCASH FLOWS**

(in thousands)

(unaudited)

 
| ** **                                                                                          | ** ** | **Six Months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| **2004**                                                                                            | ** ** | **2003**                      | ** ** |
|                                                                                                |       |                          |       |   |   |
| **Cash flows from operating activities:**                                                           |       |                          |       |   |   |
| Net income (loss)                                                                                   |       | $                             | (9,512     | ) | $ | 1,211 |   |
| Adjustments to reconcile net (loss) income  to net cash (used in) provided by operating activities: |       |                          |       |   |   |
| Depreciation and amortization                                                                       |       | 382                           |       | 434 |   |
| Loss on disposal of equipment                                                                       |       | —                        |       | 121 |   |
| Cumulative effect of change in accounting  principle                                                |       | —                        |       | 190 |   |
| Accretion of asset retirement obligation  liability                                                 |       | —                        |       | 33 |   |
| Common stock issued for services                                                                    |       | —                        |       | 4 |   |
| Stock options and warrants issued for  services                                                     |       | (8                            | )          | 272 |   |
| Stock-based employee compensation                                                                   |       | 340                           |       | 590 |   |
| Change in operating assets and liabilities:                                                         |       |                          |       |   |   |
| Prepaid expenses and other assets                                                                   |       | 442                           |       | 661 |   |
| Accounts payable                                                                                    |       | (35                           | )          | (338 | ) |
| Accrued liabilities                                                                                 |       | 262                           |       | (901 | ) |
| Net cash (used in) provided by operating  activities                                                |       | (8,129                        | )          | 2,277 |   |
|                                                                                                |       |                          |       |   |   |
| **Cash flows from investing activities:**                                                           |       |                          |       |   |   |
| Proceeds from sales and maturities of  investment securities                                        |       | 7,695                         |       | 11,867 |   |
| Purchases of investment securities                                                                  |       | (29                           | )          | (14,115 | ) |
| Facilities and equipment purchases                                                                  |       | (164                          | )          | (47 | ) |
| Licensed products                                                                                   |       | (1,000                        | )          | — |   |
| Proceeds from sales of equipment                                                                    |       | —                        |       | 188 |   |
| Net cash provided by (used in) investing  activities                                                |       | 6,502                         |       | (2,107 | ) |
|                                                                                                |       |                          |       |   |   |
| **Cash flows from financing activities:**                                                           |       |                          |       |   |   |
| Proceeds from stock options and warrants  exercised                                                 |       | 380                           |       | 480 |   |
| Repayment of note payable principal                                                                 |       | (163                          | )          | (201 | ) |
| 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 (used in) financing  activities                                                |       | 9,009                         |       | (21 | ) |
|                                                                                                |       |                          |       |   |   |
| Net increase  in cash and  cash equivalents                                                         |       | 7,382                         |       | 149 |   |
|                                                                                                |       |                          |       |   |   |
| **Cash and  cash equivalents:**                                                                     |       |                          |       |   |   |
| Beginning of  period                                                                                |       | 15,166                        |       | 6,564 |   |
| End of  period                                                                                      |       | $                             | 22,548     |   | $ | 6,713 |   |
|                                                                                                |       |                          |       |   |   |
| **Supplemental disclosure of non-cash  financing activity:**                                        |       |                          |       |   |   |
| Issuance of  common stock to settle accrued bonuses                                                 |       | $                             | —     |   | $ | 33 |   |
| Cash paid for interest                                                                              |       | $                             | 97         |   | $ | 122 |   |
| Purchase of Licensed Products with common  stock                                                    |       | $                             | 1,000      |   | $ | — |   |

 

See accompanying notes to the condensedconsolidated financial statements.

# ** **

5

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**NEORX CORPORATION AND SUBSIDIARY**

** **

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

** **

# **Note 1.**  Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statementsinclude the accounts of NeoRx Corporation and subsidiary (the Company).  All intercompany balances and transactionshave been eliminated in consolidation.

 

The interim financialstatements contained herein have been prepared pursuant to the rules andregulations 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 interim financial statements reflectall adjustments, consisting only of normal recurring accruals necessary topresent fairly the Company’s financial position as of June 30, 2004 and theresults of operations and cash flows for the periods ended June 30, 2004 and2003.

 

The results of operationsfor the periods ended June 30, 2004 and 2003 are not necessarily indicative ofthe expected operating results for the full year.

 

Certain prior periodamounts have been reclassified to conform to the current year presentation.

* *

*StockBased Compensation*:  The Company accounts for its stock optionplans for employees in accordance with the provisions of Accounting PrinciplesBoard (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations.  Compensationexpense related to employee stock options is recorded if, on the date of grant,the fair value of the underlying stock exceeds the exercise price.  The Company applies the disclosure-onlyrequirements of Statement of Financial Accounting Standard (SFAS) No. 123,“Accounting for Stock-Based Compensation”, which allows entities to continue toapply the provisions of APB Opinion No. 25 for transactions with employees andto provide pro forma results of operations disclosures for employee stockoption grants as if the fair-value based method of accounting in SFAS No. 123had been applied to these transactions. Stock compensation costs related to fixed employee awards with pro ratavesting are recognized on a straight-line basis over the period of benefit,generally the vesting period of the options. For options and warrants issued to non-employees, the Company recognizesstock compensation costs utilizing the fair value methodology prescribed inSFAS No. 123 over the related period of benefit.

 

Had compensation cost for these stock option plans for employeesbeen determined using the fair value based method of accounting under SFAS No.123, the Company’s net income (loss) applicable to common shares and net income(loss) per share would have been the pro forma amounts indicated below (inthousands, except per share data):

 
| ** **                                                                                         | ** ** | **Quarter ended June  30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                                                                         | ** ** | **2004**                    | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)  applicable to common shares:                                                    |       |                        |       |                           |       |   |   |   |   |
| As reported                                                                                        |       | $                           | (4,707     | )                              | $          | 5,203 |   | $ | (9,762 | ) | $ | 961 |   |
| Add: Stock-based  employee compensation expense included in reported net loss                      |       | 340                         |       | 590                            |       | 340 |   | 590 |   |
| Deduct: Stock-based  employee compensation determined under fair value based method for all awards |       | (612                        | )          | (1,255                         | )          | (957 | ) | (1,737 | ) |
| Pro forma                                                                                          |       | $                           | (4,979     | )                              | $          | 4,538 |   | $ | (10,379 | ) | $ | (186 | ) |
| Net earnings (loss) per  common share, basic and diluted:                                          |       |                        |       |                           |       |   |   |   |   |
| As reported:                                                                                       |       |                        |       |                           |       |   |   |   |   |
|                                                                                               |       |                        |       |                           |       |   |   |   |   |
| Basic                                                                                              |       | $                           | (0.16      | )                              | $          | 0.19 |   | $ | (0.33 | ) | $ | 0.04 |   |
| Diluted                                                                                            |       | $                           | (0.16      | )                              | $          | 0.18 |   | $ | (0.33 | ) | $ | 0.03 |   |
| Pro forma:                                                                                         |       |                        |       |                           |       |   |   |   |   |
| Basic                                                                                              |       | $                           | (0.16      | )                              | $          | 0.17 |   | $ | (0.35 | ) | $ | (0.01 | ) |
| Diluted                                                                                            |       | $                           | (0.16      | )                              | $          | 0.16 |   | $ | (0.35 | ) | $ | (0.01 | ) |

 

6

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The per shareweighted-average fair value of stock options granted during the quarters endedand six months ended June 30, 2004 and 2003 was $1.98, $2.02, $2.25, $0.87,respectively, on the grant date using the Black-Scholes option pricing modelwith the following weighted average assumptions:

 

| ** **              | ** ** | **Quarter ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **2004**                    | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected dividend rate  |       | 0.0                         | %          | 0.0                            | %          | 0.0 | % | 0.0 | % |
| Risk-free interest rate |       | 3.49                        | %          | 2.06                           | %          | 3.47 | % | 2.29 | % |
| Expected volatility     |       | 122.0                       | %          | 138.2                          | %          | 122.1 | % | 135.3 | % |
| Expected life in years  |       | 4.00                        |       | 4.00                           |       | 4.00 |   | 4.00 |   |

# ** **

# **Note 2.**  Net Income (Loss) Per Common Share

 

Basic and diluted income (loss) per share are based on net income(loss) applicable to common shares, which is comprised of income net (loss) andpreferred stock dividends in all periods presented. Shares used to calculatebasic income (loss) per share are based on the weighted average number ofcommon shares outstanding during the period. Shares used to calculate diluted income (loss) per share are based onthe potential dilution that would occur upon the exercise or conversion ofsecurities into common stock using the treasury stock method.  Calculations of basic and diluted income(loss) per share exclude the effect of the following stock options and warrantsto purchase additional shares of common stock because the share incrementswould not be dilutive.

 
| ** **            | ** ** | **Quarter ended  June 30,** | ** ** | **Six Months ended   June 30,** | ** ** |
|-----------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **2004**                    | ** ** | **2003**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|                  |       |                        |       |                            |       |   |   |   |   |
| Common stock options  |       | 4,174,192                   |       | 2,717,260                       |       | 4,174,192 |   | 3,620,030 |   |
| Common stock warrants |       | 1,587,500                   |       | 890,000                         |       | 1,587,500 |   | 890,000 |   |

 

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 June 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 June 30, 2004because the effect of including such shares would not be dilutive.

 

7

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**Note 3.****  Comprehensive (Loss)Income**

 

The Company’s comprehensive (loss) income for the quarters ended June30, 2004 and 2003 was $(4,589,000) and $5,340,000, respectively.  The comprehensive (loss) income for thequarters ended June 30, 2004 and 2003 consisted of net (loss) income of$(4,582,000) and $5,328,000, respectively, and a net unrealized (loss) gain oninvestment securities of $(7,000) and $12,000 for the quarters ended June 30,2004 and 2003, respectively. The comprehensive (loss) income for the six monthsended June 30, 2004 and 2003 was $(9,513,000) and $1,270,000,respectively.  The comprehensive (loss)income for the six months ended June 30, 2004 and 2003 consisted of net (loss)income of $(9,512,000) and $1,211,000, respectively, and a net unrealized(loss) gain on investment securities of $(1,000) and $59,000 for the six monthsended June 30, 2004 and 2003, respectively.

# ** **

# **Note 4.**  Asset Retirement Obligation

 

The Companyrecorded a $0.2 million cumulative effect of change in accounting principleduring the first three months of 2003 as a result of the Company’s adoption ofSFAS No. 143, Accounting for Asset Retirement Obligations.  Under SFAS No. 143, the Company recorded anasset and liability in the amount of $0.4 million related to the estimated fairvalue of future decommissioning costs associated with the Dentonradiopharmaceutical manufacturing facility. The real estate and equipmentassociated with the manufacturing facility for which the decommissioning costswere estimated were sold in December 2003. The sale of these assets eliminated the future asset retirementobligation as recorded under SFAS 143 as of December 31, 2003.  Accretion of the asset retirement obligationtotaled $33,000 and depreciation expense for the asset retirement asset totaled$26,000 for the six months ended June 30, 2003.

# ** **

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

 

In February 2004, the Company raised $9.0 million in net proceedsthrough the sale in a private placement (the 2004 Financing) of 1,845,000shares of common stock.  The new commonshareholders also received five-year warrants to purchase an aggregate of922,500 shares of common stock at $7.00 per share.  Thewarrants are exercisable beginning on February 23, 2004 and, thereafter, areexercisable at any time during their term. The warrants contain provisions requiring the adjustment of theexercise price and number of shares issuable if the Company sells (other thanin connection with certain permitted transactions, such as strategiccollaborations and acquisitions approved by the board of directors) shares ofcommon stock at a price lower than the then-current exercise price of thewarrants.  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 stockissued in the 2004 Financing, and the shares of commonstock issuable upon exercise of the warrants related thereto, have beenregistered with the SEC.

# ** **

# **Note 6.**  Liquidity

 

The Company will need toraise additional capital to fund its Skeletal Targeted Radiotherapy (STRTM)phase III clinical trial and other proposed STR studies, development of itsnewly acquired platinum-based compound, NX 473 (see Note 7), and futureoperating cash needs.  In April 2003 theCompany received $10 million from the sale to Boston Scientific Corporation ofcertain non-core NeoRx intellectual property and the grant to Boston ScientificCorporation of certain license rights. In December 2003 the Company raised approximately $14.6 million in netproceeds through the sale in a private placement of shares of a newly createdclass of Series B Convertible Preferred Stock (Series B Preferred Stock), whichare convertible, 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.  The Company raisedapproximately $9.0 million in net proceeds from the sale of common stock andwarrants in a private placement transaction in February 2004.  The Company intends to use the net proceedsfrom these financings for general working capital and to support its STR phaseIII pivotal trial.  With the proceeds ofthese offerings, the Company believes that its present cash, cash equivalents,investment securities and expected interest income will be sufficient to fundits anticipated working capital and capital requirements with respect to itsSTR programs at least through the third quarter of 2005.  The Company will require additional funds forits NX 473 clinical program, which currently is expected to begin in the firsthalf of 2005.  In the event thatsufficient additional funds are not obtained, the Company may be required todelay, reduce or curtail the scope of its NX 473 clinical program andother product development efforts.

 

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During 2002, the Company discontinued all Pretarget® clinical andresearch activities, reduced staffing by 67% and terminated,effective in April 2003, the lease for its facilities at 410 West HarrisonStreet in Seattle.  PretargetÒtechnology 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 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 certain developmentgoals, plus royalties on potential future product sales.  The sale of the Pretarget intellectualproperty relieves the Company from the annual costs of maintaining thePretarget patent estate.  During 2003 theCompany spent approximately $350,000 for the prosecution and maintenance of thePretarget patents and trademarks.  For2004, these costs were expected to be in the range of $200,000 to$600,000.  See Note 7 below foradditional information about the Pretarget transaction.

 

In connection with its 2001 purchase of the radiopharmaceuticalmanufacturing plant and other assets located in Denton, TX, the Company assumed$6,000,000 principal amount of restructured debt held by Texas State Bank,McAllen, TX.  The loan, which matures inApril 2009, is secured by the assets acquired in the transaction.  The interest rate on the loan was 4.25% onJune 30, 2004.  The interest rate isequal to the bank prime rate and adjusts on the same date that the bank primerate changes.  The loan provides for amaximum annual interest rate of 18%. Principal and interest are payable in monthly installments.  Principal and interest paid on the noteduring the quarters ended June 30, 2004 and 2003 totaled $115,000 and $139,000,respectively. Principal and interest paid on the note during the six monthsended June 30, 2004 and 2003 totaled $255,000 and $323,000, respectively.  In December 2003, the Company sold anon-essential portion of its Denton facility, the proceeds of which ($827,000)were applied to reduce the outstanding balance on the loan.  As of June 30, 2004 the outstanding balanceof the loan was $4,334,000.  The fixedmonthly payments on the note are recalculated in April of each year based onthe then current bank prime interest rate and outstanding note balance.  The bank prime interest rate of 4.00% was ineffect on the payment recalculation date, resulting in an estimated total fixedpayment obligation in 2004, reflecting both principal and interest, of$486,000.

 

During 2002 and early 2003, the Company reduced the staff at the Dentonfacility to four employees and operated the facility in standby mode.   In the second half of 2003, the Companyre-staffed the facility in preparation for resumption of manufacturing activitiesin the first quarter of 2004.  The termsof the Texas State Bank loan provide that an event of default may be deemed tooccur if the Company abandons, vacates or discontinues operations on asubstantial portion of the Denton facility or there is a material adversechange in the Company’s operations. The Company does not believe that operatingthe facility in standby mode during 2002 and early 2003 violated theseprovisions, nor has Texas State Bank suggested that it views such activities asa potential violation. The Company can provide no assurance, however, thatTexas State Bank will not at some time in the future seek to rely on these orother provisions of the loan to declare the Company in default of the loan. Ifthis were to occur, Texas State Bank could declare the entire outstandingamount of the loan ($4,334,000 at June 30, 2004) due and immediately payable.In such case, the Company’s cash resources and assets could be impaireddepending on its ability to raise funds through a sale of the Denton facilityand other means. Based on a November 2002 appraisal of the Dentonfacility, the fair value of the facility and its assets exceeds the amount ofthe outstanding debt.

 

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 a strategic partnership forSTR and NX 473 development and commercialization.  The Company also may address its need foradditional capital by pursuing opportunities for the licensing, sale or divestitureof certain 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,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.

 

The Company’s actual capital requirementswill depend upon numerous factors, including:

 

•             the rate of progressand costs of its clinical trial and research and development activities,including costs and availability of clinical materials from third-partysuppliers, and the Company’s ability to manufacture STR in a timely andcost-effective manner;

 

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•             actionstaken by the US Food and Drug Administration (FDA) and other regulatoryauthorities;

 

•             thescope and timing of the Company’s NX 473 clinical program;

 

•             thecosts of discontinuing projects and technologies or decommissioning existingfacilities, if the Company undertakes those activities;

 

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

 

•             theCompany’s degree of success in commercializing STR and its other cancer therapyproduct candidates;

 

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

 

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

 

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

# ** **

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

 

LicensedProducts represent the worldwide exclusive rights, excluding Japan, to develop,manufacture and commercialize NX 473, a platinum-based anti-cancer agent,acquired from AnorMED, Inc., in April 2004 and are accounted for at cost, lessaccumulated amortization.  Amortizationis computed on a straight-line basis over an estimated useful life of twelveyears.  Under the terms of the licensingagreement with AnorMED, the Company paid a one-time upfront milestone paymentof $1 million in NeoRx common stock and $1 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. Upon regulatory approval, AnorMED would receive royalty payments of upto 15% on product sales.  Under theagreement, the Company acquired an exclusive license, under a portfolio ofissued patents and patent applications, to develop, manufacture andcommercialize NX 473.  The agreement alsoexclusively licenses to the Company certain know-how pertaining to NX 473,including clinical and manufacturing data, regulatory submissions, and relatedinformation.

 

Alsoin April 2004, the Company sold to Aletheon Pharmaceuticals, Inc. the Company’sPretarget® intellectual property.  Underthe agreement, the Company could receive up to $6.6 million in milestonepayments if Aletheon achieves certain development goals, plus royalties onpotential future product sales.  TheCompany did not receive cash at the time of sale to Aletheon.  The Pretarget intellectual property that theCompany transferred to Aletheon under the agreement includes a portfolio ofUnited States and foreign issued patents and patent applications, and trademarkregistrations and applications.  The saleof the Pretarget intellectual property relieves the Company from thesignificant annual costs of maintaining the Pretarget patent estate.Seattle-based Aletheon is a development stage biotherapeutics company foundedby two former Company employees.  Thetiming 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.  As described in Note 6 above, the Companydiscontinued its Pretarget clinical studies in July 2002.

 

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** **

**Item 2****.****           Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

This Form 10-Q containsforward-looking statements. These statements relate to future events or futurefinancial performance. In some cases, you can identify forward-lookingstatements 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.

 

Although we believe theexpectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements. 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.

 

NeoRx and STR are ourtrademarks or registered trademarks in the United States and/or foreigncountries.  Pretarget® is a trademark ofAletheon Pharmaceuticals, Inc. in the United States and/or foreign countries.

*** ***

***Critical Accounting Policies and Estimates***

 

Our critical accounting policies andestimates have not changed from those reported in our Annual Report on Form10-K for the year ended December 31, 2003. For a more complete description, please refer to our Annual Report onForm 10-K.

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

###### ***Quarterand six months ended June 30, 2004 compared to quarter and six months endedJune 30, 2003***

** **

**Revenue for the second quarter of 2004 was $0.5 million,compared with $10.2 million for the second quarter of 2003.  Revenue for the six months ended June 30,2004 was $1.0 million, compared with $10.3 million for the six months endedJune 30, 2003.  Revenue for the secondquarter and the first six months of 2004 consisted of milestone payments fromBoston Scientific Corporation.  Revenuefor the second quarter and the first six months of 2003 consisted of $10.0million from the assignment and license to Boston Scientific Corporation ofcertain non-core intellectual property and revenue from a facilities leaseagreement.**

** **

Total operating expenses for the second quarter of 2004 increased 4% to$5.1 million, from $4.9 million for the second quarter of 2003, and increased18% to $10.6 million for the six months ended June 30, 2004, from $8.9 millionfor the same period in 2003.

 

Research and development expenses increased 14% to $3.1 million for thesecond quarter of 2004, from $2.7 million for the second quarter of 2003, andincreased 29% to $6.9 million for the six months ended June 30, 2004, from $5.3million for the same period in 2003.  Theincrease in R&D expenses for the second quarter of 2004 resulted fromincreased costs associated with operating the Company’s radiopharmaceuticalmanufacturing facility in Denton, Texas at near normal levels and siteinitiation costs related to the STR phase III trial.

 

General and administrative expensesdecreased 8% to $2.0 million for the second quarter of 2004, compared with $2.2million for the second quarter of 2003, and increased 2% to $3.7 million forthe six months ended June 30, 2004, from $3.6 million for the same period in2003.  The decrease in G&A costs forthe second quarter of 2004 relates primarily to lower personnel costs.

 

Cash and investment securities as of June30, 2004 were $27.2 million, compared with $27.5 million at December 31,2003.  The Company believes that itsexisting cash and investment securities will be sufficient to fund itsanticipated working capital and capital requirements with respect to its STRprograms at least through the third quarter of 2005.  The Company will require additional funds forits NX 473 clinical programs, which currently is expected to begin in the firsthalf of 2005.  In the event thatsufficient additional funds are not obtained, the Company may be required todelay, reduce or curtail the scope of its NX 473 clinical program and otherproduct development efforts.

 

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***Major Research and Development Projects***

 

Our major researchand development projects during the fiscal quarters ended June 30, 2004 and2003 were Skeletal Targeted Radiotherapy (STRTM) and Pretarget® technology.

 

Skeletal Targeted Radiotherapy.  We are developing STR for the treatment ofmultiple myeloma, a cancer originating in the bone marrow.  STR is designed to deliver radiationspecifically to sites of cancer in the bone and bone marrow.  STR consists of a bone-seeking moleculecalled DOTMP, which deposits the radioactive substance, holmium-166, in theskeleton.  We have incurred costs of approximately $50.6 millionin connection with the STR program since the program’s inception in 1998.

 

InOctober 2003, we reached agreement with the FDA on our STR phase IIIclinical trial design. This agreement, called a Special Protocol Assessment,establishes the number of patients to be studied and how and when the drug’ssafety and effectiveness will be determined. At the same time, the FDAconfirmed 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 toannounce the opening of clinical sites or the enrollment of patients. Weanticipate that the phase III trial will take several years to complete, and wedo not expect to submit a New Drug Application (NDA) before mid-2007 for thepotential approval of STR by the FDA. The actual time to completion of our STRphase III clinical trial depends upon numerous factors, including:

 

•             ourability to obtain adequate additional funding;

 

•             ourreceipt of approvals by the FDA and other regulatory agencies and the timingthereof;

 

•             otheractions by regulators;

 

•             therate of progress and costs of our other clinical trial and research anddevelopment activities;

 

•             our ability toproduce sufficient, reliable and affordable supplies of the STR compound forclinical      studies, and to accessthird-party supplies of holmium-166, the radioactive substance used in our STRproduct candidate, as well as other materials used in the manufacture of the STRcompound;

 

•             thecosts of maintaining manufacturing operations;

 

•             theextent of scheduling conflicts with participating clinicians and clinicalinstitutions; and

 

•             ourability to identify and enroll patients who meet trial eligibility criteria.

 

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

 

Material cash inflows relating to our STR developmentwill not commence until after marketing approvals are obtained, if they areobtained, and then only if STR finds acceptance in the marketplace. To date, wehave not received any revenues from product sales of STR.

 

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

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

 

•             We may be unable toobtain regulatory approval of the drug or may be unable to obtain such approval

 

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on a timely basis;

 

**•**             Wemay be unable to continue to manufacture or otherwise secure adequate suppliesof STR in order to complete the phase III clinical trial and initiatecommercial launch upon approval;

 

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

 

•             We would not earn anysales revenue from STR, which would increase the likelihood that we would needto obtain additional financing for our other development efforts; and

 

•             Our reputation amonginvestors might be harmed, which could make it more difficult for us to obtainequity capital on attractive terms or at all.

 

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

Our development administration overhead costs,consisting of rent, utilities, consulting fees, patent costs and other variousoverhead costs, are included in total research and development expense for eachperiod, but are not allocated among our various projects.  Our total development costs include the costsof various other research efforts directed toward the identification of futureproduct candidates.  These other researchprojects are pre-clinical and not considered major projects.  Our total research and development costs are summarizedbelow:

 

| ** **                           | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|----------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **2004**                   | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                 |       |                       |       |                           |       |   |   |   |   |
| STR                                  |       | $                          | 2,325      |                           | $          | 1,430 |   | $ | 5,371 |   | $ | 3,135 |   |
| Other overhead and research costs    |       | 784                        |       | 1,298                          |       | 1,520 |   | 2,204 |   |
|                                 |       |                       |       |                           |       |   |   |   |   |
| Total research and development costs |       | $                          | 3,109      |                           | $          | 2,728 |   | $ | 6,891 |   | $ | 5,339 |   |

 

 

###### ***Liquidityand capital resources***

 

The Company has financed its operations primarily through the sale ofequity securities, technology licensing, collaborative agreements and debtinstruments.  We invest excess cash ininvestment securities that will be used to fund future operating costs.  Cash, cash equivalents and investmentsecurities totaled $27,216,000 at June 30, 2004 compared to $27,501,000 atDecember 31, 2003.  We primarily fundcurrent operations with our existing cash and investments.  Cash used by operating activities for the six months ended June30, 2004 totaled $8,129,000.  Revenuesand other income sources for the second quarter of 2004 were not sufficient tocover operating expenses.

 

In 2000, we established a line of credit with Pharmaceutical ProductDevelopment, Inc. (PPD) of up to $5.0 million to assist in funding the pivotalphase III trial of our STR product candidate. The line, which carried an annualinterest rate of 16%, expired in February 2004. No funds were drawn against the line through the date of termination.

 

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On April 17, 2003, weentered into agreements with Boston Scientific Corporation relating to the saleto Boston Scientific of certain non-core intellectual property and the grant toBoston Scientific of certain license rights. Under the first agreement, weassigned to Boston Scientific certain intellectual property in exchange for acash payment of $9 million.  Theintellectual property assigned to Boston Scientific included a portfolio ofNeoRx patents and patent applications in the cardiovascular field. Under asecond agreement, we granted to Boston Scientific an exclusive license to usecertain other NeoRx intellectual property, for which we received a one-timecash payment of $1 million.  Theexclusive license grants Boston Scientific the right to use, in certain medicaldevice fields, a separate portfolio of NeoRx patents and patent applicationsresulting from our collaboration with University of Cambridge investigators.

 

In October 2003 weannounced that we had reached agreement with the FDA, under the SpecialProtocol Assessment (SPA) process, on the design of the phase III clinicaltrial for STR.  We also confirmed withthe FDA that a single phase III study is sufficient for registration of STR,provided that the drug is shown to be safe and effective in the trial.  The phase III trial planned under the SPAwill be a randomized, controlled study of STR in patients with primaryrefractory multiple myeloma.  The trialis expected to enroll approximately 240 evaluable patients.    The FDA accepted complete response at sixmonths post-transplant as a surrogate endpoint for efficacy in the phase IIItrial.   Acceptance of a surrogate endpoint places STRon the Accelerated Approval path.  We arerequired to follow the phase III patients for survival as our phase IV(post-marketing) commitment.  Totalestimated costs to complete the STR clinical trial and potentially obtainmarketing approval are in the range of $35-40 million, including the cost ofclinical drug supply.

 

In December 2003, we raised approximately $14.6 million in net proceedsthrough the sale in a private placement of shares of a newly created class ofSeries B Convertible Preferred Stock, which are convertible, at a price of$5.00 per share, into 3,150,000 shares of common stock, and warrants topurchase an aggregate of 630,000 common shares at $6.00 per share.  Additionally, we raised approximately $9.0million in net proceeds from the sale of common stock and warrants in a privateplacement transaction in February 2004. We intend to use the net proceeds from these financings for generalworking capital and to support our phase III pivotal trial.  With the proceeds of these offerings, webelieve that our present cash, cash equivalents, investment securities andexpected interest income will be sufficient to fund our anticipated workingcapital and capital requirements with respect to our STR programs at leastthrough the third quarter of 2005.  Wewill require additional funds for our NX 473 clinical program, which currentlyis expected to begin in the first half of 2005. In the event that sufficient additional funds are not obtained, we maybe required to delay, reduce or curtail the scope of our NX 473 clinicalprogram and other product development efforts.

 

In connection with our 2001 purchase of the radiopharmaceuticalmanufacturing plant and other assets located in Denton, TX, we assumed $6,000,000principal amount of restructured debt held by Texas State Bank, McAllen,TX.  The loan, which matures in April2009, is secured by the assets acquired in the transaction.  The interest rate on the loan was 4.25% onJune 30, 2004.  The interest rate isequal to the bank prime rate and adjusts on the same date that the bank primerate changes.  The loan provides for amaximum annual interest rate of 18%. Principal and interest are payable in monthly installments.  Principal and interest paid on the noteduring the quarters ended June 30, 2004 and 2003 totaled $115,000 and $139,000,respectively.  Principal and interestpaid on the note during the six months ended June 30, 2004 and 2003 totaled$255,000 and $323,000, respectively. In December 2003, we sold anon-essential portion of our Denton facility, the proceeds of which ($827,000)were applied to reduce the outstanding balance on the loan. As of June 30,2004, the outstanding balance of the loan was $4,334,000. The fixed monthlypayments on the note are recalculated in April of each year based on the thencurrent bank prime interest rate and outstanding note balance. The bank primeinterest rate of 4.00% was in effect on the payment recalculation date in April2004, resulting in an estimated total fixed payment obligation in 2004,reflecting both principal and interest, of $486,000.

 

During 2002 and early 2003, we reduced the staff at the Denton facilityto four employees and operated the facility in standby mode.  In the second half of 2003, we re-staffed thefacility in preparation for resumption of manufacturing activities in the firstquarter of 2004.  The terms of the TexasState Bank loan provide that an event of default may be deemed to occur if weabandon, vacate or discontinue operations on a substantial portion of theDenton facility or there is a material adverse change in our operations.  We do not believe that operating the facilityin standby 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 not some time in the future seek to rely onthese or other provisions of the loan to declare us in default of theloan.  If this were to occur, Texas StateBank could declare the entire outstanding amount of the loan ($4,334,000 atJune 30, 2004) due and immediately payable. In such case, our cash resourcesand assets could be impaired depending on our

 

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ability to raise funds through a sale ofthe Denton facility and other means. Based on a November 2002 appraisal of the Denton facility, the fairvalue of the facility and its assets exceeds the amount of the outstandingdebt.

 

In April 2004, weacquired from AnorMED, Inc. the worldwide exclusive rights, excluding Japan, todevelop, manufacture and commercialize NX 473, a platinum-based anti-canceragent.  Under the terms of the agreement,we paid AnorMED a one-time upfront milestone payment of $1.0 million in ourcommon stock and $1.0 million in cash. The agreement also provides for additional milestone payments to AnorMEDof up to $13 million, payable in cash or a combination of cash and our common stock.  Upon regulatory approval, AnorMED wouldreceive royalty payments of up to 15% on product sales.  In phase II trials conducted by the priorlicensee of the compound, NX 473 has been shown to be active in a variety ofcancers, including ovarian cancer, lung cancer and prostate cancer.  NX 473 also exhibits the potential to beavailable in both oral and intravenous formulations. We expect to file an INDapplication for NX 473 later this year for a phase II study in lung cancer anda phase I/II study in colorectal cancer. The timing and scope of those studies will depend in part on our abilityto secure a contractor to fill and finish bulk drug substance and our abilityto raise capital.  We are currentlyhaving fill-and finish of the intravenous formulationof the drug performed by a contract manufacturer.  We expect the drug to be available forclinical studies in the first quarter of 2005.

 

Alsoin April 2004, we sold and transferred to Aletheon Pharmaceuticals, Inc. ourPretarget® intellectual property.  Underthe agreement, we could receive up to $6.6 million in milestone payments ifAletheon achieves certain development goals, plus royalties on potential futureproduct sales.  We did not receive anyupfront consideration for the sale of the Pretarget property.  We discontinued our clinical studies usingthe Pretarget technology in July 2002, and since that time, had been activelyseeking, both through targeted inquiries and a broad-based auction process, abuyer or licensee for the technology. The sale of the Pretarget intellectual property relieves us of theannual costs associated with maintaining the Pretarget patent estate.  During 2003, the Company spent approximately$350,000 for the prosecution and maintenance of the Pretarget patents 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 raise additional capital tofund our STR phase III clinical trial and other proposed STR studies,development of our newly-acquired platinum-based compound, NX 473, and futureoperating cash needs.  We may seek toraise capital through the sale of equity and/or debt securities or the developmentof other funding mechanisms. We are seeking to form a strategic partnership forSTR 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 thatsufficient additional funds are not obtained through strategic partneringopportunities, sales of securities, licensing arrangements and/or sales ofassets on a timely basis, we plan to reduce expenses through the delay,reduction or curtailment of our product development activities and/or furtherreduction of costs for facilities and administration.

 

Our actual capital requirements willdepend upon numerous factors, including:

 

•             the rate of progressand costs of our clinical trial and research and development activities,including costs and availability of clinical material from third-partysuppliers, and our ability to manufacture STR in a timely and cost-effectivemanner;

 

•             actionstaken by the FDA and other regulatory authorities;

 

•             thescope and timing of our NX 473 clinical program;

 

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

 

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

 

•             ourdegree of success in commercializing STR and other cancer therapy productcandidates;

 

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

 

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

 

There can be no assurance that we will beable 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 general, and the life science capital market specifically,may affect our potential financing sources and opportunities for strategicpartnering.  Our financial statements areprepared on a going concern basis; however, if we are forced to liquidate ourassets, we may not be able to recover the carrying amount of such assets.

 

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*** ***

***Related party transactions***

 Dr. Frederick Craves, a director of theCompany, is a founder and current chairman of the board of Bay City Capital,LLC, also known as BCC, a merchant bank focused on the life sciencesindustry.  Carl Goldfischer, a Companydirector, also is a managing director of BCC. Jack Bowman, who retired as NeoRx’s Chief Executive Officer and Chairmanof the Board of Directors in May 2004, was on the business advisory board ofBCC.  The Company and BCC entered into anagreement whereby BCC acted as the Company’s advisor for the purpose ofidentifying opportunities to enter into strategic alliances and providedassistance relating to structuring and negotiating such transaction. TheCompany paid a retainer fee of $26,667 for the first quarter of 2003 and$25,000 for each quarter thereafter to the end of 2003. Retainer fee expensesunder this agreement totaled $101,667.  Theagreement also included a percentage of gross value of cash, securities,property or other consideration derived from a transaction, ranging from one tofive percent, depending on the ultimate amount of consideration raised.  BCC agreed to exclude the Boston ScientificCorporation sale and assignment of intellectual property from this provision ofits agreement with the Company, and, therefore, received no commission or othercompensation related to the Boston Scientific transaction.  This agreement expired December 31, 2003, andthe Company has elected not to renew it. The Company believes that the fees associated with this contract areequivalent to market prices for similar service at independent investmentbanks.

In connection with consulting servicesperformed in 2003, Dr. Paul G. Abrams, a former Chief Executive Officer of theCompany, received consulting fees of approximately $76,600 for the quarterended June 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 $9,000 for the quarterended June 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 June 30, 2003. This agreement terminated on October 7, 2003.

On June 26, 2003, the compensation committeeapproved effective with the resignation of Douglass B. Given,formerly the Company’s President and Chief Executive Officer, on June 30, 2003,the accelerated vesting of all outstanding stock options granted by the Companyto Dr. Given. These options were exercisable until June 30, 2004. Mr.Given exercised 232,570 of these options through June 2004. The balance ofthese options were 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 areexercisable until December 31, 2004.

 

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

 

In addition to the other information contained in this report, youshould carefully read and consider the following risk factors before purchasingour common stock. Each of these******risks could harm our business,******operating resultsand financial condition, as well as decrease the value of an investment in ourstock.  An investment in NeoRx securitiesinvolves 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 June 30, 2004, we had an accumulated deficit of$224.2 million. Our net loss for the quarter ended June 30, 2004 was $4.6million.  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 endedDecember 31, 2001. These losses have resulted principally from costsincurred in our research and development programs and from our general andadministrative activities. To date, we have been engaged only in research anddevelopment activities and have not generated any significant revenues fromproduct sales. We do not anticipate that our proposed STRTM (Skeletal TargetedRadiotherapy) product will be commercially available for several years, if atall. We expect to incur additional operating losses in the future. These lossesmay

 

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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.

 

**We will need to raise additional capital, andour future access to capital is uncertain.**

 

It is expensive to develop cancer therapy products and conduct clinicaltrials for these products. Total estimated costs to complete the STR phase IIIclinical trial and potentially obtain marketing approval are in the range of$35-40 million, including the cost of clinical drug supply. Although wecurrently 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 the expenseof our operations and the conduct of our clinical trials and preclinicalresearch. We will need to raise additional capital to:

 

•             fund operations;

 

•             continue research anddevelopment of STR and any other product candidates;

 

•             commercialize STR orany other proposed products; and

 

•             develop and implementa clinical program for our newly-acquired NX 473 platinum compound.

 

We believe that our available cash and investment securities will besufficient to fund our anticipated working capital and capital requirementswith respect to our STR programs at least through the third quarter of2005.  We will require additional fundsfor our NX 473 clinical program, which currently is expected to begin in thefirst half of 2005.  In the event thatsufficient additional funds are not obtained, we may be required to delay,reduce or curtail the scope of our NX 473 clinical program and otherproduct development efforts.

 

We may seek to raise capital through the sale of equity and/or debtsecurities or the development of other funding mechanisms. We are seeking toform a strategic partnership for STR and NX 473 development andcommercialization. We also may address our need for additional capital bypursuing opportunities for the licensing, sale or divestiture of certain non-coreintellectual property and other assets. The amount of additional financing weneed will depend on a number of factors, including the following:

 

•             the rate of progressand costs of our clinical trial and research and development activities, includingcosts and availability of clinical materials from third-party suppliers, andour ability to manufacture STR in a timely and cost-effective manner;

 

•             actionstaken by the FDA and other regulatory authorities;

 

•             thescope and timing our NX 473 clinical program;

 

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

 

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

 

•             ourdegree of success in commercializing STR and our other cancer therapy productcandidates;

 

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

 

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

 

We may not be able to obtain additional financing on a timely basis, onfavorable terms, or at all. If we are unable to raise additional funds when weneed them, we may be required to delay, reduce or eliminate some or all of

 

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our development programs and some or all ofour clinical trials. For example, in July 2002, in order to preservelimited resources, 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 cost considerationsand limited access to funding to, as occurred with the Pretarget program,discontinue development and testing of product candidates in which we haveinvested considerable time and money. Additionally, we may be forced to partnerwith third parties to develop or commercialize products or technologies that weotherwise would have sought to develop independently. Such relationships maynot be on terms as commercially favorable to us as might otherwise be the case.If we raise additional funds by issuing common stock or securities convertibleinto or exercisable for common stock, further dilution to shareholders mayresult, and new investors could have rights superior to current securityholders.

 

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

 

The manufacture and marketing of our proposed STR product and ourresearch and development activities are subject to regulation for safety,efficacy and quality by the FDA in the United States and comparable authoritiesin other countries.

 

The process of obtaining FDA and other required regulatory approvals,including foreign approvals, is expensive, often takes many years and can varysubstantially depending on the type, complexity and novelty of the productsinvolved. Our STR product candidate is novel; therefore, regulatory agencieslack direct experience with it. This may lengthen the regulatory reviewprocess, increase our development costs and delay or prevent commercializationof our STR product candidate.

 

In October 2000, the FDA placed all of our clinical trials of STRon clinical hold because of a serious toxicity that developed in about 10% ofpatients treated with STR on our STR phase I/II trials in multiple myeloma.This toxicity, which is called thrombotic thrombocytopenic purpura/hemolyticuremic syndrome (TTP/HUS), emerged six to 13 months after treatment. As acondition to lifting the clinical hold, the FDA requested that we collectadditional data from a small number of multiple myeloma patients to validatethe patient-specific dosing method we used in earlier studies of STR and whichwe proposed to use in our planned pivotal trial program. In addition, the FDAasked us to quantify the exposure of certain organs, including the kidney, thebone and the bone marrow, to radiation from STR. Quantification of the exposureof internal organs to radiation is called dosimetry. The dosimetry study alsoused an adjusted radiation dosage and a revised administration regimen. Wesubmitted data from our dosimetry study to the FDA in February 2003, alongwith a proposal for further clinical development of STR in patients withprimary refractory myeloma (myeloma that has not been responsive toconventional first-line chemotherapy), using a revised dosing method. The FDAlifted the clinical hold in April 2003.

 

TTP/HUS is a syndrome that sometimes occurs in patients conditioned forbone marrow transplant with total body irradiation. It is believed to becaused, at least in part, by radiation injury to the kidneys. Of the sevenpatients who developed TTP/HUS believed to be related to treatment with STR,two were alive at last follow-up in 2003. Three patients died with diseaseprogression, making it difficult to determine the cause of death, and twopatients died without disease progression, suggesting that TTP/HUS may havebeen a cause of death. Our studies indicated that the occurrence ofdrug-related TTP/HUS in the phase I/II trials was dependent on the dose of STRadministered. The lowest dose at which drug-related TTP/HUS occurred was 938 mCi/m2. In the phase III trial, the dose ofSTR has been reduced to 750 mCi/m2. Nocases of drug-related TTP/HUS have been seen among the ten patients treated inthe phase I/II studies at comparable doses of STR.

 

No cancer product using our technologies has been approved formarketing. Consequently, there is no precedent for the successfulcommercialization of products based on our technologies. In addition, we havehad only limited experience in filing and pursuing applications necessary togain regulatory approvals. This may impede our ability to obtain timelyapprovals from the FDA or foreign regulatory agencies. We will not be able tocommercialize our STR product candidate until we obtain regulatory approval,and consequently any delay in obtaining, or inability to obtain, regulatoryapproval could harm our business.

 

If we violate regulatory requirements at any stage, whether before orafter marketing approval is obtained, we may be fined, forced to remove aproduct from the market or experience other adverse consequences, including

 

 

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delay, which could materially harm ourfinancial results. Additionally, we may not be able to obtain the labelingclaims necessary or desirable for product promotion. In addition, if we orother parties identify serious side effects after any of our products are onthe market, 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 of clinical trials andmanufacturing and marketing of our proposed STR product outside the UnitedStates vary widely from country to country. Foreign approvals may take longerto obtain than FDA approvals and can involve additional testing. Foreign regulatoryapproval processes include all of the risks associated with the FDA approvalprocesses. Also, approval of a product by the FDA does not ensure approval ofthe same product by the health authorities of other countries.

 

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

 

We opened the phase III trial of STR to patient enrollment in March2004 and plan to 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:

 

•             ourability to obtain adequate additional funding;

 

•             ourreceipt of approvals by the FDA and other regulatory agencies and the timingthereof;

 

•             otheractions by regulators;

 

•             therate of progress and costs of our other clinical trial and research anddevelopment activities;

 

•             our ability toproduce sufficient, reliable and affordable supplies of the STR compound forclinical      studies, and to accessthird-party supplies of holmium-166, the radioactive substance used in our STRproduct candidate, as well as other materials used in the manufacture of theSTR compound;

 

•             thecosts of maintaining manufacturing operations;

 

•             theextent of scheduling conflicts with participating clinicians and clinicalinstitutions; and

 

•             ourability to identify and enroll patients who meet trial eligibility criteria.

 

We may not advance or complete our planned phase III clinical trial forour STR product candidate as projected, may not conduct it successfully, or maynot complete it at all.

 

We currently rely on academic institutions and clinical researchorganizations to conduct, supervise or monitor some or all aspects of clinicaltrials involving our proposed STR product. Further, we are seeking to enterinto license agreements, partnerships or other collaborative arrangements tosupport financing, development and commercialization of our STR productcandidate. To the extent that we now or in the future participate in suchcollaborative arrangements, we will have less control over the timing, planningand other aspects of our clinical trials. If we fail to advance or complete, orexperience delays in or are forced to curtail our planned clinical programs,our stock price and our ability to conduct our business could be harmed.

 

**If testing of a particular product does notyield successful results, we will be unable to commercialize that product.**

 

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

 

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

 

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

 

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

 

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

 

•             the effects of ourpotential products may not be the desired effects or may include undesirableside       effects or othercharacteristics that preclude regulatory approval or limit their commercial useif    approved.

 

Clinical testing is very expensive, can take many years, and theoutcome is uncertain. The data that we may collect from our phase III clinicaltrial may not be sufficient to support regulatory approval of our proposed STRproduct. The clinical trials of our STR product and other proposed products maynot be completed on schedule, and the FDA or foreign regulatory agencies maynot ultimately approve any of our product candidates for commercial sale. Ourfailure to adequately demonstrate the safety and efficacy of a cancer therapyproduct under development would delay or prevent regulatory approval of theproduct, which would prevent us from marketing the proposed product.

 

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

 

Results of early preclinical and clinical trials are based on a limitednumber of patients and may, upon review, be revised ornegated by authorities or by later stage clinical results. Historically, theresults from preclinical testing and early clinical trials often have not beenpredictive of results obtained in later clinical trials. A number of new drugsand therapeutics have shown promising results in initial clinical trials, butsubsequently failed to establish sufficient safety and effectiveness data toobtain necessary regulatory approvals. Data obtained from preclinical and clinicalactivities are subject to varying interpretations, which may delay, limit orprevent regulatory approval.

 

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

 

For our STR product to be successful, we need sufficient, reliable andaffordable supplies of the STR compound for clinical studies. This requiresdeveloping and maintaining reliable and affordable third-party suppliers ofcommercial quantities of the radioactive substance holmium-166, and thetargeting agent DOTMP, used in our STR product candidate. Sources of thesematerials may be limited, and we, or potential third-party suppliers of the STRcompound, may be unable to obtain these materials in amounts and at pricesnecessary to successfully commercialize our STR product. Timely delivery of theholmium-166 component material and of the finished STR compound is critical.For example, holmium-166 loses its effectiveness for treating patients within ashort period of time. As a result, the STR product must be shipped within24 hours of its manufacture to the site where the patient is to betreated. Failures or delays in the manufacturing and shipping processes couldcompromise the quality and effectiveness of our product.

 

There are, in general, relatively few sources of the holmium-166component of our STR product. Historically, we have depended on a single sourcevendor, the University of Missouri Research Reactor facility group (MURR)located in Columbia, Missouri. In March 2004, we entered into a contract, underwhich MURR is responsible for the manufacture, including process qualification,quality control, packaging and shipping, of holmium-166 for our phase IIItrail.  Our contract with MURR is for aninitial term of one year, which we may extend for up to two additionalyears.  The contract may be terminated byeither party if the other party breaches the contract and such breach is notcured, if MURR fails to fulfill our purchase orders on a timely basis, or ifany regulatory authority orders either party to stop manufacturing or usingholmium-166.  Under the contract, we paya fixed price per unit of holmium-166 ordered, subject to certain minimumpurchase requirements, and fixed amounts for handling and maintenance.  While MURR generally has provided usmaterials with acceptable quality, quantity and cost in the past, it may becomeunable or unwilling to meet our future demands, or demands of potentialthird-party suppliers of our STR compound. If MURR or an alternate supplier isunable or unwilling to provide supplies of holmium-166 at a cost and on otherterms acceptable to us, the manufacture and delivery of our STR productcandidate could be impaired, and we may suffer delays in, or be prevented from,initiating or completing further clinical trials of our STR product candidate.

 

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We obtain DOTMP, the targeting agent for STR, from The Dow ChemicalCompany, from which we license the STR technology. Because we license the STRtechnology from Dow, we historically have not felt it necessary to enter into aformal supply agreement with Dow. We currently have a sufficient supply ofDOTMP on hand to complete our phase III studies.

 

**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 the radiopharmaceuticalmanufacturing plant and other assets located in Denton, TX, we assumed$6,000,000 principal amount of restructured debt held by Texas State Bank,McAllen, TX.  The loan, which matures inApril 2009, is secured by the assets acquired in the transaction.  The interest rate on the loan was 4.25% onJune 30, 2004.  The interest rate isequal to the bank prime rate and adjusts as the prime rate changes.  The loan provides for a maximum annualinterest rate of 18%.  Principal andinterest are payable in monthly installments. Principal and interest paid on the note during the second quarter of2004 totaled $231,000.  InDecember 2003, we sold a non-essential portion of our Denton facility, theproceeds of which ($827,000) were applied to reduce the outstanding balance onthe loan. As of June 30, 2004, the outstanding balance of the loan was$4,334,000. 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 staff at the Denton facilityto four employees and operated the facility in standby mode. In the second halfof 2003, we re-staffed the facility in preparation for resumption ofmanufacturing activities in the first quarter of 2004. The terms of the TexasState Bank loan provide that an event of default may be deemed to occur if weabandon, vacate or discontinue operations on a substantial portion of theDenton facility or there is a material adverse change in our operations. We donot believe that operating the facility in standby mode during 2002 and early2003 violated these provisions, nor has Texas State Bank suggested that itviews such activities as a potential violation. We can provide no assurance,however, that Texas State Bank will not some time in the future seek to rely onthese or other provisions of the loan to declare us in default of the loan. Ifthis were to occur, Texas State Bank could declare the entire outstandingamount of the loan ($4,334,000 at June 30, 2004) due and immediately payable.In such case, our cash resources and assets could be impaired depending on ourability to raise funds through a sale of the Denton facility and other means.Based on a November 2002 appraisal of the Denton facility, the fair valueof the facility and its assets exceeds 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 part on our ability to attractand maintain collaborative partners and relationships to support thedevelopment, sale, marketing, distribution and manufacture of STR, NX 473 andany other future product candidates and technologies 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 Dowagreement, our total milestone payments to Dow would be $8,500,000. We cannotbe certain of the extent of our success, if any, in commercializing STR andattaining established milestones. The license agreement may be terminated byeither party for breach. We can terminate the license at any time upon priorwritten notice to Dow. Dow may terminate the license if we cease to carry onour business as a result of liquidation, bankruptcy or insolvency. If notearlier terminated, the license agreement will continue in effect untilexpiration of all patents licensed under the agreement. We currently anticipatesuch expiration date to be February 3, 2015. Upon expiration of the Dowlicense agreement, we will retain from Dow a fully paid-up license to useunpatented technology related to STR. If Dow were to breach its obligationsunder the license, or if the license expires or is terminated and we cannotrenew, replace, extend or preserve our rights under the license agreement, ourSTR development efforts and our business could be significantly adverselyaffected.

 

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Our second material collaborative agreement is the exclusive worldwide(except Japan) license granted to us by AnorMED, Inc. for the development andcommercial sale of an anti-cancer platinum compound, NX 473.  Under that license, we are solely responsiblefor the development and commercialization of NX 473. AnorMED retains theobligation, at its cost, to prosecute patent applications and maintain, extendand defend all patents.  The partiesexecuted the license agreement in April 2004, at which time we paid AnorMED aone-time upfront milestone payment of $1.0 million in NeoRx common stock and$1.0 million in cash.  The agreement alsoprovides for additional milestone payments to AnorMED of up to $13 million,payable in cash or a combination of cash and NeoRx common stock. Thesemilestones include our successful completion of an NX 473 phase II study orinitiation of an NX 473 phase III study, submission to the FDA of an NDAfor NX 473, regulatory approval from the FDA of NX 473 and theattainment of certain levels of annual net sales of NX 473.  Upon regulatory approval, AnorMED also wouldreceive royalty payments of up to 15% on product sales.  We cannot be certain of the extent of oursuccess, if any, in commercializing NX 473 and attaining establishedmilestones.  The license agreement may beterminated by either party for breach, if the other party files a petition inbankruptcy or insolvency or for reorganization, or is dissolved, liquidated ormakes assignment for the benefit of creditors. We can terminate the license atany time upon prior written notice to AnorMED. If not earlier terminated, thelicense agreement will continue in effect, in each country in the territory inwhich the licensed product is sold or manufactured, until the earlier of (i)expiration of the last valid claim of a pending or issued patent covering thelicensed product in that country or (ii) a specified number of years afterfirst commercial sale of the licensed product in that country.  We expect to file an IND application for NX473 later this year for a phase II study in lung cancer and a phase I/II studyin colorectal cancer.  If AnorMED were tobreach its obligations under the license, or if the license expires or isterminated and we cannot renew, replace, extend or preserve our rights underthe license agreement, we would be unable to move forward with our plan toundertake NX 473 clinical studies.

 

In connection with our STR product development and manufacturingactivities, we rely on third-party contractors to perform for us, or assist uswith, certain specialized services, including process support and equipmentvalidation at the Denton facility, drug dispensing, distribution and shipping,and clinical trial management. We are not materially dependent on ourrelationship with any of these contractors. However, because these contractorsprovide specialized services, their activities and quality of performance maybe outside our direct control. If these contractors do not perform theirobligations in a timely manner, or if we encounter difficulties with thequality of services we receive from these contractors, we may incur additionalcosts and delays in our STR phase III trial and any other product developmentactivities, which could have a material negative effect on our business.

 

None of our current employees has any experience selling, marketing anddistributing therapeutic products. To the extent we are successful in obtainingapproval for the commercial sale of STR or any other product candidate,we may need to secure one or more corporate partners to conduct theseactivities. We may not be able to enter into partnering arrangements in atimely manner or on terms acceptable to us. To the extent that we enter intoco-promotion or other licensing arrangements, our product revenues are likelyto be lower than if we directly marketed and sold our products, and anyrevenues we receive would depend upon the efforts of third parties, which effortsmay not be successful. If we are not able to secure adequate partneringarrangements, we would have to hire additional employees or consultants withexpertise in sales, marketing and distribution. Employees with relevant skillsmay not be available to us. Additionally, any increase in the number ofemployees would increase our expense level and could have a material adverseeffect 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, couldadversely affect our ability to proceed with our STR phase III trials on atimely and cost-effective basis.**

 

In April 2001, we purchased a manufacturing facility and certainother assets located in Denton, TX. In addition to the manufacturing facility,we purchased existing equipment, documentation and certain processes. Thefacility is operated in accordance with current Good Manufacturing Practices(cGMP) and was issued appropriate radiation permits by the Texas Department ofHealth. This manufacturing facility assumed responsibility for all aspects ofthe manufacture of the STR compound, including process qualification, qualitycontrol, packaging and shipping, and production of the clinical material forour completed STR dosimetry study. We believe that the Denton facility has thecapabilities and capacity to serve as the principal manufacturing site for theSTR compound for our phase III clinical trial and for potential commercialmanufacture.  We resumed ourmanufacturing activities at the Denton facility in February 2004. Our abilityto continue to utilize the Denton facility as our primary manufacturing sitefor the STR compound in the future will depend on a number of factors,including:

 

•             actionstaken by the FDA and the timing thereof;

 

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

 

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

 

•             thecosts of maintaining manufacturing operations;

 

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

 

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

 

If in the future we decide to transition the STR production process toa third-party supplier, such third-party supplier could require significantstart-up time to qualify and implement the manufacturing process. In such case,our ability to move forward with further STR clinical and commercialdevelopment could be adversely affected and we may incur significant additionalcosts in connection with manufacturing operations. Further, there can be noassurance that manufacturing alternatives would be available on a timely orcost-effective basis.

 

We, or any potential third-party manufacturers, must continuouslyadhere to cGMP regulations enforced by the FDA through its facilitiesinspection program. If our facilities or the facilities of these manufacturerscannot pass a pre-approval plant inspection, the FDA will not grant an NDA forour proposed products. In complying with cGMP and foreign regulatoryrequirements, we and any of our third-party manufacturers will be obligated toexpend time, money and effort in production, record-keeping and quality controlto assure that our products meet applicable specifications and otherrequirements. If we, or any of our third-party manufacturers, fail to complywith these requirements, we may be subject to regulatory 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.**

 

The competition for development of cancer therapies is intense. Thereare numerous competitors developing products to treat the diseases for which weare seeking to develop products. We initially are focusing clinical developmentof our STR product 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 VelcadeTM therapeutic for treatment ofmultiple myeloma patients who have received at least two prior therapies anddemonstrated disease progression on the last therapy. In addition, a number ofestablished pharmaceutical companies, including GlaxoSmithKline, Novartis AGand Bristol-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 competition from universities andother non-profit research organizations. These institutions, which carry out asignificant amount of cancer research and development, are becomingincreasingly aware of the commercial value of their findings and more active inseeking patent and other proprietary rights, as well 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 on obtaining, maintaining andenforcing our patents and other proprietary rights and our ability to avoidinfringing the proprietary rights of others. Patent law relating to the scopeof claims in the biotechnology field in which we operate is still evolving and,consequently, patent positions in our industry may not be as strong as inother, better-established fields. Accordingly, the United States Patent andTrademark Office (USPTO) may not issue patents from the patent applicationsowned by or licensed to us. If issued, the patents may not give us an advantageover competitors with similar technologies.

 

We own over 100 patents issued in the United States and in foreignjurisdictions and have licenses to additional patents. However, the issuance ofa patent is not conclusive as to its validity or enforceability and it is

 

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uncertain how much protection, if any, will be given to our patents ifwe attempt to enforce them and they are challenged in court or in otherproceedings, such as oppositions, which may be brought in foreign jurisdictionsto challenge the validity of a patent. A third party may challenge the validityor enforceability of a patent after its issuance by the USPTO. It is possiblethat a competitor may successfully challenge our patents or that a challengewill result in limiting their coverage. Moreover, the cost of litigation touphold the validity of patents and to prevent infringement can be substantial.If the outcome of litigation is adverse to us, third parties may be able to useour patented invention without payment to us. Moreover, it is possible thatcompetitors may infringe our patents or successfully avoid them through designinnovation. We may need to file lawsuits to stop these activities. These lawsuitscan be expensive and would consume time and other resources, even if we weresuccessful in stopping the violation of our patent rights. In addition, thereis a risk that a court would decide that our patents are not valid and that wedo not have the right to stop the other party from using the inventions. Thereis also the risk that, even if the validity of our patents was upheld, a courtwould refuse to stop the other party on the ground that its activities do notinfringe our patents.

 

In addition, the protection afforded by issued patents is limited induration. With respect to our STR product in development in the United States,we currently rely primarily on US patent numbers USPN 4,882,142 (expiringDecember 19, 2008) and USPN 5,059,412 (expiring October 22, 2008),both of which are licensed to us by The Dow Chemical Company, and USPN6,767,531 issued to NeoRx (expiring June 12, 2020). We may be able to rely onthe Hatch-Waxman Act to extend the term of a US patent covering STR afterregulatory approval of STR in the United States. In addition, we have patentapplications pending in the United States that include claims directed to thetreatment of bone-associated cancers (including multiple myeloma) using the STRproduct with other cancer treatments.

 

Under our license agreement with Dow, Dow retains the obligation, atits cost, to prosecute patent applications and maintain, extend and defend alllicensed patents. Dow has the first right to sue any third party infringers ofthe STR patents. If Dow does not file suit, we have the right to sue theinfringer at our own expense.

 

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

 

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

 

Our competitors or others may have or may acquire patent rights thatthey could enforce against us. In such case, we may be required to alter ourproducts, pay licensing fees or cease activities. If our products conflict withpatent rights of others, third parties could bring legal actions against usclaiming damages and seeking to enjoin manufacturing and marketing of theaffected products. If these legal actions are successful, in addition to anypotential liability for damages, we could be required to obtain a license inorder to continue to manufacture or market the affected products. We may notprevail in any legal action and a required license under the patent may not beavailable 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 other proceedings relating tointellectual property rights, even if resolved in our favor, could besubstantial. Some of our competitors may be better able to sustain the costs ofcomplex patent litigation because they have substantially greater resources. Ifthere is litigation against us, we may not be able to continue our operations.If third parties file patent applications, or are issued patents claimingtechnology also claimed by us in pending applications, we may be required to participatein interference proceedings in the USPTO to determine priority of invention. Wemay be required to participate in interference proceedings involving our issuedpatents and pending applications. We may be required to cease using thetechnology or license rights from prevailing third parties as a result of anunfavorable outcome in an interference proceeding. A prevailing party in thatcase may not offer us a license on commercially acceptable terms.

 

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

 

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

 

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

 

Our research and development and manufacturing processes, as well asthe manufacturing processes that may be used by our collaborators, involve thecontrolled use of hazardous and radioactive materials. As a result, we aresubject to foreign, federal, state and local laws, rules, regulations andpolicies governing the use, generation, manufacture, storage, air emission,effluent discharge, handling and disposal of certain materials and wastes inconnection with our use of these materials. Although we believe that our safetyprocedures for handling and disposing of such materials comply with thestandards prescribed by such laws and regulations, we may be required to incursignificant costs to comply with environmental and health and safetyregulations in the future. In the event that we discontinue operations in facilitiesthat have had past research and manufacturing processes where hazardous orradioactive materials have been in use, we may have significant decommissioningcosts associated with the termination of operation of these facilities. Thesepotential decommissioning costs also may reduce the market value of thefacilities and may limit our ability to sell or otherwise dispose of thesefacilities in a timely and cost-effective manner. In addition, the risk ofaccidental contamination or injury from hazardous or radioactive materialscannot be completely eliminated. In the event of such an accident, we could beheld liable for any resulting damages, and any such liability could exceed ourresources. Our current insurance does not cover liability for the clean-up ofhazardous waste materials or other environmental risks.

 

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

 

The levels of revenues and profitability of biotechnology companies maybe affected by the continuing efforts of government and third-party payors tocontain or reduce the costs of healthcare through various means. For example,in certain foreign markets, pricing or profitability of prescriptionpharmaceuticals is subject to governmental control. In the United States, therehave been, and we expect that there will continue to be, a number of federaland state proposals to implement similar governmental controls. It is uncertainwhat legislative proposals will be adopted or what actions federal, state orprivate payors for healthcare goods and services may take in response to anyhealthcare reform proposals or legislation. Even in the absence of statutorychange, market forces are changing the healthcare sector. We cannot predict theeffect healthcare reforms may have on the development, testing,commercialization and marketability of our proposed cancer therapy products.Further, to the extent that such proposals or reforms have a material adverseeffect on the business, financial condition and profitability of othercompanies that are prospective collaborators for certain of our potentialproducts, our ability to commercialize our products under development may beadversely affected. In addition, both in the United States and elsewhere, salesof prescription pharmaceuticals depend in part on the availability ofreimbursement to the consumer from third-party payors, such as governmental andprivate insurance plans. Third-party payors are increasingly challenging theprices charged for medical products and services. If we succeed in bringing oneor more products to market, we cannot be certain that these products will beconsidered cost-effective and that reimbursement to the consumer will beavailable or will be sufficient to allow us to sell our products on acompetitive or profitable basis.

 

**The loss of key employees could adverselyaffect our operations.**

 

Since July 2002, we have implemented three reductions in force.Also in January 2003, we accepted the resignations of Richard Ghalie, MD,Vice President, Medical and Regulatory Affairs, and Les Sabo, Vice President,Manufacturing. Jack L. Bowman was named Executive Chairman and became Chairmanof our Board of Directors on March 11, 2003. Douglass B. Given, MD, PhD, resigned as President, Chief Executive Officer anda Director of the Company on June 30, 2003. On that date,Mr. Bowman was named Chief Executive Officer and KarenAuditore-Hargreaves, PhD, was promoted to Chief Operating Officer of theCompany. Dr. Auditore-Hargreaves was elected

 

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President of the Company effective December 5, 2003.Neile Grayson, PhD, resigned as Vice President, Corporate Development, inJanuary 2004. Although Mr. Sabo and Drs. Given and Grayson wereofficers of the Company, we did not, at the time of their resignations,consider them key employees in terms of our STR product development activitiesor other programs. Dr. Ghalie, as Vice President, Medical and RegulatoryAffairs, was considered a key employee of the Company. We did not experienceany material disruptions or delays as a consequence of the resignations of anyor all of Mr. Sabo and Drs. Grayson, Given or Ghalie. Dr. Given andMr. Sabo have been replaced. Dr. Grayson’s position has beeneliminated and her responsibilities reassigned to other members of management.Dr. Ghalie’s position currently is vacant, and we are actively seeking areplacement. We elected to delay recruiting a replacement for Dr. Ghalieuntil the FDA-imposed clinical hold on STR was lifted. In the interim, medicaland other professional employees of the Company and outside consultants haveperformed, 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.  On that date, Michael K. Jackson was promotedto Chief Accounting Officer and assumed responsibility for senior financialduties on an interim basis.  As principalfinancial officer, Ms. Kile was considered a key employee of the Company, andwe intend to seek a replacement.  We didnot experience any material disruptions or delays as a consequence of Ms. Kile’sresignation.

 

Jerry McMahon, Ph.D. was appointed Chief Executive Officer of theCompany, effective May 11, 2004, and was named Chairman of the Board ofDirectors in June 2004.  Mr. Bowmanretired from his position as Chief Executive Officer effective May 11, 2004,and he did not stand for reelection as a director of the Company at theCompany’s Annual Meeting of Shareholders held on May 18, 2004.  Mr. Bowman was considered a key employee ofthe Company.  We did not experience anymaterial disruption or delays as a consequence of Mr. Bowman’s retirement.

As of June 30, 2004, we had a total workforce of 39 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. The loss of theservices of one or more of these individuals could delay our STR productdevelopment activities or other programs and research and development efforts.We do not maintain key-person life insurance on any of our officers, employeesor consultants.

 

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

 

We have change in control agreements and severance agreements with allof our executive officers and consulting agreements with variousof our scientific advisors. Our agreements with our executive officers providefor “at will” employment, which means that each executive may terminate his orher service with us at any time. In addition, our scientific advisors mayterminate their services to us at any time. As of the date of this report, nocurrent key employee has announced his or her intention to leave the company.

 

**Risks Related to Our Common Stock**

 

**Our common stock listing was transferred fromThe Nasdaq National Market to The Nasdaq SmallCapMarket; failure to maintain continued listing on Nasdaq could affect its marketprice and liquidity.**

 

Our common stock listing was transferred from The NasdaqNational Market to The Nasdaq SmallCap Market on March 20, 2003. Weelected to seek a transfer to The Nasdaq SmallCapMarket because we had been unable to regain compliance with The Nasdaq NationalMarket minimum $1.00 bid price requirement for continued listing. Bytransferring to The SmallCap Market, we were afforded an extended grace periodin which to satisfy The SmallCap Market $1.00 minimum bid price requirement. OnMay 6, 2003, we received notice from Nasdaqconfirming that we are in compliance with the $1.00 SmallCap minimum bid pricerequirement. As a result of rule changes adopted by Nasdaq in March 2003,we will not be eligible to relist our common stock on The Nasdaq NationalMarket unless and until our common stock maintains a minimum bid price of $5.00per share for 90 consecutive trading days and we otherwise comply with theinitial listing requirements for The Nasdaq National Market. Trading on The Nasdaq SmallCap Market may have a negative impact on thevalue of our common stock,

 

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because securities trading on The NasdaqSmallCap Market typically are less liquid than those traded on The Nasdaq NationalMarket.

 

If our common stock is delisted from The NasdaqSmallCap Market, we would likely seek quotation on the American Stock Exchangeor a regional stock exchange, if available. Such listing could reduce themarket 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 The Nasdaq SmallCap Market, and ifwe fail to obtain quotation on another market or exchange, and if the tradingprice remains below $5.00 per share, then trading in our common stock mightalso become subject to the requirements of certain rules promulgated under theSecurities Exchange Act of 1934, which require additional disclosure bybroker-dealers in connection with any trade involving a stock defined as a“penny stock” (generally, any equity security not listed on a nationalsecurities exchange or quoted on Nasdaq that has a market price of less than$5.00 per share, subject to certain exceptions). Many brokerage firms arereluctant to recommend low-priced stocks to their clients. Moreover, variousregulations and policies restrict the ability of shareholders to borrow againstor “margin” low-priced stocks, and declines in the stock price below certainlevels may trigger unexpected margin calls. Additionally, because brokers’commissions on low-priced stocks generally represent a higher percentage of thestock price than commissions on higher priced stocks, the current price of thecommon stock can result in an individual shareholder paying transaction coststhat represent a higher percentage of total share value than would be the caseif our share price were higher. This factor may also limit the willingness ofinstitutions to purchase our common stock. Finally, the additional burdensimposed upon broker-dealers by these requirements could discouragebroker-dealers from facilitating trades in our common stock, which couldseverely limit the market liquidity of the stock and the ability of investorsto 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 significant volatility in the market pricesof securities of biotechnology companies, including our common stock. The highand low closing sale prices for our common stock were $6.05 and $0.28 in 2002.In 2003, the high and low closing sale prices were $6.47 and $0.37. The highand low closing sale prices during the period from January 2, 2004 throughAugust 3, 2004 were $5.78 and $1.67. Our stock price has been and may continueto be affected by this type of market volatility, as well as our ownperformance. Our business and the relative price of our common stock may beinfluenced by a large variety of factors, including:

 

•             announcementsby us or our competitors concerning acquisitions, strategic alliances,technological       innovations and newcommercial products;

 

•             theavailability of critical materials used in developing and manufacturing ourproposed STR product;

 

•             theprogress and results of clinical trials;

 

•             developmentsconcerning patents, proprietary rights and potential infringement;

 

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

 

•             ouravailable cash.

 

In addition, potential public concern about the safety of our proposedSTR product and any other products we develop, comments by securities analysts,our ability to maintain the listing of our common stock on the Nasdaq system,and conditions in the capital markets in general and in the life sciencecapital market specifically, may have a significant effect on the market priceof our common stock. The realization of any of the risks described in this report,as well as other factors, could have a material adverse impact on the marketprice of our common stock and may result in a loss of some or all of yourinvestment in NeoRx.

 

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

 

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

 

Our articles of incorporation authorize our board of directors to issueup to 3,000,000 shares of preferred stock and to determine the price, rights,preference, privileges and restrictions, including voting rights, of thoseshares without any further vote or action by our shareholders.

 

We have adopted a shareholder rights plan, which is intended to protectthe rights of shareholders by deterring coercive or unfair takeover tactics.The board of directors declared a dividend to holders of our common stock ofone preferred share purchase right for each outstanding share of common stock.In addition, under certain circumstances, holders of our Series BConvertible Preferred Stock are entitled to receive one preferred sharepurchase right for each share of common stock into which their Series Bpreferred stock may be converted. The rights are exercisable ten days followingthe offer to purchase or acquisition of beneficial ownership of 20% of theoutstanding common stock by a person or group of affiliated persons. Each rightentitles the registered holder, other than the acquiring person or group, topurchase from NeoRx one-hundredth of one share of Series A Junior Participating Preferred Stock at the price of $40,subject to adjustment. The rights expire April 10, 2006. In lieu ofexercising the right by purchasing one one-hundredth of one share ofSeries A preferred stock, the holder of the right, other than theacquiring person or group, may purchase for $40 that number of shares of ourcommon stock having a market value of twice that price.

 

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

 

•             amerger or consolidation with, disposition of assets to, or issuance orredemption of stock to or from the acquiring person;

 

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

 

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

 

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

 

The provisions of our articles of incorporation, shareholder rightsplan and Washington law discussed above may have the effect of delaying,deterring or preventing a change of control of NeoRx, even if this change wouldbe beneficial to our shareholders. These provisions also may discourage bidsfor our common stock at a premium over market price and may adversely affectthe market price of, and the voting and other rights of the holders of, ourcommon stock. In addition, these provisions could make it more difficult toreplace or remove our current directors and management in the event ourshareholders believe this would be in the best interests of the corporation andour 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 and Warrant PurchaseAgreement and Certificate of Designation for our Series B ConvertiblePreferred Stock may require us to obtain the approval of the holders ofSeries B preferred stock to amend, alter or repeal any provision of theCertificate of Designation which may be deemed to materially adversely affectthe rights of the holders of Series B preferred stock or to authorize,create or issue any class or series of securities having liquidation or otherrights superior to those of the Series B preferred stock. TheSeries B preferred stock also contains provisions requiring the adjustmentof the conversion price and the number of issuable common shares if we 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 Bpreferred stock) shares of common stock at prices lower than the then currentconversion price of the Series B preferred stock. Warrants issued to investorsin our February 2004 common stock financing

 

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(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 B preferred stock, at aconversion price of $5.00 per share, are currently convertible into 3,150,000shares of common stock. In addition, warrants accompanying the Series Bpreferred stock, at an exercise price of $6.00 per share, are exercisable for630,000 shares of common stock. These shares of common stock, when issued uponconversion of the Series B preferred stock and exercise of the warrants,have been registered with the SEC and are generally available for immediateresale in the public market.  We issuedin the 2004 Financing 1,845,000 shares of common stock and warrants, at anexercise price of $7.00 per share, exercisable into 922,500 shares of commonstock. The shares of common stock issued in the 2004 Financing,and the shares of common stock issuable upon exercise of the warrants relatedthereto, have been registered with the SEC and are generally available forimmediate resale in the public market. The market price of our common stock could fall as a result of suchresales due to the increased number of shares available for sale in the market.

# ** **

# **Item 3**.  Quantitative and Qualitative Disclosuresabout Market Risk

 

The Company is exposed tothe impact of interest rate changes and changes in the market values of itsinvestments.

 

**Interest Rate Risk**

 

The Company’s exposure to market rate risk for changes in interestrates relates primarily to the Company’s debt securities included in itsinvestment portfolio.  The Company doesnot have any derivative financial instruments. The Company invests in debt instruments of the US Government and itsagencies and high-quality corporate issuers. Investments in both fixed rate and floating rate interest earninginstruments carry a degree of interest rate risk.  Fixed rate securities may have their fairmarket value adversely impacted due to 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 to changesin interest rates or the Company may suffer losses in principal if forced tosell securities that have declined in market value due to changes in interestrates.  At June 30, 2004, the Companyowned government debt instruments totaling $4.7 million and owned no corporatedebt securities. The Company’s exposure to losses as a result of interest ratechanges is managed through investing primarily in securities with relativelyshort maturities of up to three years and securities with variable interest rates.  The Company’s debt securities as of June 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 the note was $4,334,000 on June 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 ofand with the participation of the Company’s management, including the Company’sChairman and Chief Executive Officer and the Corporate Controller and ChiefAccounting Officer, the Company has evaluated the effectiveness and design andoperation of its disclosure controls and procedures as of the end of thequarter and, based on their evaluation, the Chairman and Chief ExecutiveOfficer and the Corporate Controller and Chief Accounting 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.

 

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There were no changes inthe Company’s internal controls over financial reporting that occurred duringthe quarter that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PART II****.****  OTHER INFORMATION**

 

**Item 2.****  Changes inSecurities and Use of Proceeds**

 

On April 2 2004, theCompany executed a license agreement to acquire from AnorMED, Inc. theworldwide exclusive rights, excluding Japan, to develop, manufacture andcommercialize NX 473, a platinum-based anti-cancer agent.  As partial consideration for the license, theCompany issued to 243,711 shares of its common stock, at $4.10 per share, toAnorMed in a private placement transaction exempt under Section 4(2) of theSecurities Act of 1933.  The market priceof the shares issued was determined based on the volume-weighted average of thedaily closing prices of Company common stock for the 10 consecutive tradingdays preceding the date of the license agreement.

** **

**Item 4.****  Submissionof Matters to a Vote of Security Holders**

The Company’s annual meeting of shareholderswas held on May 18, 2004.  The followingnominees were elected as directors, each to hold office until his successor iselected and qualified, by the vote set forth below:

 
| **Nominee**         | ** ** | **For**    | ** ** | **Abstain** | ** ** |
|---------------------|------------|------------|------------|-------------|------------|
|                |       |       |       |        |       |
| Frederick B. Craves |       | 24,618,213 |       | 586,540     |       |
| E. Rolland Dickson  |       | 25,404,316 |       | 586,540     |       |
| Carl S. Goldfischer |       | 24,642,305 |       | 586,540     |       |
| Alan A. Steigrod    |       | 25,396,575 |       | 586,540     |       |
| David B. Stevens    |       | 25,436,424 |       | 586,540     |       |
| Robert M. Littauer  |       | 24,196,236 |       | 586,540     |       |

 

Theproposal to approve the NeoRx Corporation 2004 Incentive Compensation Plan wasapproved by the vote set forth below:

 
| For     |   | 5,482,715 |   |
|---------|--------|-----------|--------|
| Against |   | 3,389,535 |   |
| Abstain |   | 139,776   |   |

** **

**Item 6.****  Exhibitsand Reports on Form 8-K**

 

(a) Exhibits – SeeExhibit Index below.

 

(b) Reports onForm 8-K:

On April 6, 2004, we filed a report on Form 8-Kannouncing the acquisition of commercialization rights to NX 473 from AnorMED,Inc., the sale and transfer of NeoRx’s Pretarget intellectual property toAletheon Pharmaceuticals, Inc. and the resignation of Melinda G. Kile as VicePresident, Finance.

On April 26, 2004, we filed a report on Form 8-Kannouncing our financial results for the quarter ended March 31, 2004.

On April 29, 2004, we filed a report on Form 8-Kannouncing the appointment of Jerry McMahon, Ph.D as Chief Executive Officer,effective May 11, 2004, and the resignation of Jack L. Bowman as ChiefExecutive Officer on the same date.

On June 10, 2004, we filed a report on Form 8-Kannouncing that the Company presented data from its phase II dosimetry study ofSTRTM (Skeletal Targeted Radiotherapy) at the 2004 Annual Meeting of theAmerican Society of Clinical Oncology (ASCO).

On June 25, 2004, we filed a report on Form 8-Kannouncing that the Board of Directors had appointed Jerry McMahon, Ph.D., asChairman.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|   |           | NEORX CORPORATION                                 |
|--------|----------------|---------------------------------------------------|
|   |           | (Registrant)                                      |
|   |           |                                              |
| Date:  | August 9, 2004 | By:                                               | /s/ MICHAEL K. JACKSON |   |
|   |           | Michael K. Jackson                                |
|   |           | Corporate Controller and Chief Accounting Officer |

 

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**EXHIBITINDEX**

** **
| **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       |       | Stock  Option Agreement, dated November 16, 2000, between NeoRx Corporation and  Douglass Given (‡)                                                                                                                                |       | (I)        |
| 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 McMahan (‡)                                                                                                                            |       | (O)        |
| 10.26       |       | Change  of Control Agreement dated as of May 11, 2004, between the Company and Jerry  McMahan (‡)                                                                                                                                  |       | (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 Corporate Controller and Chief  Accounting Officer                                                                                                                                           |       | (O)        |

 

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| 32.1     |   | Section  1350 Certification of Chairman and Chief Executive Officer                                                                                                                |   | (O)    |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| 32.2     |   | Section  1350 Certification of Corporate Controller and Chief Accounting Officer                                                                                                   |   | (O)    |
|     |
|          |
| (‡) |   | Management  contract or compensatory plan.                                                                                                                                         |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (A)      |   | Filed  as an exhibit to the Company’s Form 10-K for the fiscal year ended December  31, 2001, and incorporated herein by reference.                                           |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (B)      |   | Filed  as an exhibit to the Company’s Registration Statement on Form S-3 (No.  333-111344) filed on December 19, 2002, and incorporated herein by reference.                  |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (C)      |   | Filed  as an exhibit to the Company’s Registration Statement on Form S-3/-A  (Registration No. 333-111344) filed on February 23, 2004, and incorporated  herein by reference. |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (D)      |   | Filed  as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year  ended September 30, 1991, and incorporated herein by reference.                         |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (E)      |   | Filed  as an exhibit 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 an exhibit to the Company’s Form 10-K for the fiscal year ended December  31, 1995, and incorporated herein by reference.                                           |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (G)      |   | Filed  as an exhibit to the Company’s Registration Statement on Form S-8  (Registration No. 333-71368), filed October 10, 2001, and incorporated herein  by reference.        |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (H)      |   | Filed  as an exhibit to the Company’s Form 10-Q for the quarterly period ended March  31, 1996, and incorporated herein by reference.                                         |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (I)      |   | Filed  as an exhibit to the Company’s Form 10-K for the fiscal year ended December  31, 2000 and incorporated herein by reference.                                            |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (J)      |   | Filed  as an exhibit to the Company’s Form 10-K for the fiscal year ended December  31, 1998, and incorporated herein by reference.                                           |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (K)      |   | Filed  as an exhibit to the Company’s Form 10-Q for the quarterly period ended  September 30, 1999, and incorporated herein by reference.                                     |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (L)      |   | Filed  as an exhibit to the Company’s Form 10-Q for the quarterly period ended March  31, 2001, and incorporated herein by reference.                                         |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (M)      |   | Filed  as an exhibit to the Company’s Form 10-Q for the quarterly period ended June  30, 2002, and incorporated herein by reference.                                          |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (N)      |   | Filed  as an exhibit to the Company’s Form 10-Q for the quarterly period ended  September 30, 2002,and incorporated herein by  reference.                                     |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (O)      |   | Submitted  herewith.                                                                                                                                                               |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (P)      |   | Filed  as an exhibit to the Company’s Registration Statement on Form S-8  (Registration No. 333-115729), filed May 21, 2004, and incorporated herein by  reference.           |   |   |
|     |   |                                                                                                                                                                               |   |   |
| (Q)      |   | Filed  as an exhibit to the Company’s Form 10-Q for the quarterly period ended March  31, 2004, and incorporated herein by reference.                                         |   |   |

 

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