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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended: June 30, 2004

OR

For the transition period from              to             

Commission File Number 001-12465

CELL THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

(206) 282-7100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes  x    No  ¨.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

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CELL THERAPEUTICS, INC.

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CELL THERAPEUTICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

See accompanying notes.

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CELL THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

See accompanying notes.

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CELL THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes.

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CELL THERAPEUTICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

The accompanying unaudited financial information of Cell Therapeutics, Inc., or CTI, as of June 30, 2004 and for the three and six months ended June 30, 2004 and 2003 has been prepared in accordance with the instructions to Form 10-Q. In the opinion of management, such financial information includes all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the financial position at such date and the operating results and cash flows for such periods. Operating results for the three and six month periods ended June 30, 2004 are not necessarily indicative of the results that may be expected for the entire year. These financial statements and the related notes should be read in conjunction with our audited annual financial statements for the year ended December 31, 2003 included in our Form 10-K.

The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

Product Sales

We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, title has passed and delivery has occurred, the price is fixed and determinable, and collectibility is reasonably assured. Product sales are recorded upon shipment net of an allowance for returns and discounts. In estimating returns, we analyze historical returns, sales patterns, estimated inventory on hand at the distributors and the remaining shelf life of that inventory. Allowances for returns, discounts and bad debts, which are netted against accounts receivable, totaled approximately $2.3 million and $2.1 million at June 30, 2004 and December 31, 2003, respectively.

License and Contract Revenues

We may generate revenue from technology licenses, collaborative research and development arrangements, and cost reimbursement contracts. Revenue under technology licenses and collaborative agreements typically consists of nonrefundable and/or guaranteed technology license fees, collaborative research funding, and various milestone and product royalty or profit-sharing payments.

Revenue associated with up-front license fees, and research and development funding payments under collaborative agreements is recognized ratably over the relevant periods specified in the agreement, generally the research and development period. Revenue from substantive at-risk milestones and future product royalties is recognized as earned based on the completion of the milestones and product sales, as defined in the respective agreements. Revenue under cost reimbursement contracts is recognized as the related costs are incurred. Payments received in advance of recognition as revenue are recorded as deferred revenue.

Inventory

Inventory is stated at the lower of cost or market. Cost is determined using a weighted-average method. Finished goods inventory consists of our Food and Drug Administration, or FDA-approved, and European Agency for Evaluation of Medicinal Products, or EMEA-approved, pharmaceutical drug, TRISENOX^® (arsenic trioxide), or TRISENOX. If the cost of the inventory exceeds the expected market value, provisions are recorded for the difference between the cost and the net realizable value. When required, an allowance for excess inventory that may expire and become unsaleable is recorded. The components of inventories are as follows (in thousands):

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Research and Development Expenses

Research and development expenses include related salaries and benefits, clinical trial and related clinical trial manufacturing costs, contract and other outside service fees, and facilities and overhead costs. Research and development expenses consist of costs incurred for proprietary and collaboration research and development and also include activities such as product registries and investigator sponsored trials. Research and development costs are expensed as incurred. In instances where we enter into agreements with third parties for research, clinical trial, and related clinical trial manufacturing costs, costs are expensed upon the earlier of when non-refundable amounts are due or as services are performed. Amounts due under such arrangements may be either fixed fee or fee for service, and may include upfront payments, monthly payments, and payments upon the completion of milestones or receipt of deliverables.

Acquired in-process research and development

Costs to acquire in-process research and development, or IPRD, projects and technologies which have no alternative future use and which have not reached technological feasibility at the date of acquisition are expensed as incurred (see Note 5, “Acquisition of Novuspharma, S.p.A.”).

Derivative Financial Instruments

Effective at the beginning of fiscal 2001, we adopted Statement of Financial Accounting Standard, or SFAS, 133, Accounting for Derivative Instruments and Hedging Activities, as amended. We are subject to risks associated with fluctuations in the LIBOR interest rate from lease payments on our leased aircraft. Our policy is to hedge a portion of these forecasted transactions through an interest rate swap agreement. This swap agreement has been designated as a cash flow hedge. The portion of the net gain or loss on the derivative instrument that is effective as a hedge is reported as a component of accumulated other comprehensive loss in shareholders’ deficit and is reclassified into earnings in the same period during which the hedged transaction affects earnings. The remaining net gain or loss on the derivative in excess of the present value of the expected cash flows of the hedged transaction is recorded in earnings immediately. If a derivative does not qualify for hedge accounting, or a portion of the hedge is deemed ineffective, the change in fair value is recorded in earnings. The swap was perfectly effective at June 30, 2004 and December 31, 2003. We do not enter into forward agreements for trading purposes.

Foreign Currency Translation

For our operations that have a functional currency other than the U.S. dollar, gains and losses resulting from the translation of the functional currency into U.S. dollars for financial statement presentation are not included in determining net loss but are accumulated in the cumulative translation adjustment account as a separate component of shareholders’ deficit in accordance with SFAS 52.

Reclassifications

Certain prior year items have been reclassified to conform to current year presentation.

2. Comprehensive Loss

SFAS 130, Reporting Comprehensive Income, provides for unrealized gains and losses on our securities available-for-sale and on our interest rate swap agreement, designated as a cash flow hedge, to be included in other comprehensive loss. Also included are net exchange gains or losses resulting from the translation of assets and

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liabilities of foreign subsidiaries. Total comprehensive loss was $37.9 million and $31.0 million for the three month periods ended June 30, 2004 and 2003, respectively. Total comprehensive loss was $176.9 million and $61.5 million for the six month periods ended June 30, 2004 and 2003, respectively.

Information regarding the components of accumulated other comprehensive loss is as follows (in thousands):

3. Employee Benefit Plan

In connection with our merger with Novuspharma S.p.A on January 1, 2004, we assumed a defined benefit plan and related obligation for benefits owed to our Italian employees who, pursuant to Italian law, are entitled to a lump sum payment upon leaving for any reason. Related costs are accrued, net of applicable advances, over the employees’ service periods based on compensation and years of service. In accordance with EITF 88-1, Determination of Vested Benefit Obligation for a Defined Benefit Pension Plan, we have elected to carry the obligation under the plan at the amount of the vested benefit obligation which is defined as the actuarial present value of the vested benefit to which the employee is entitled if the employee separates immediately. As of June 30, 2004, the vested benefit obligation was approximately $1.3 million and was included in other long-term obligations.

4. Stock-Based Compensation

In accordance with SFAS 123, Accounting for Stock-Based Compensation, we elected to continue to account for employee stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion, or APB, 25, Accounting for Stock Issued to Employees, and related interpretations. Generally, compensation cost for employee stock options is measured as the excess, if any, of the market price of our common stock at the date of grant over the stock option exercise price. Compensation cost for restricted stock units equals the market price of our common stock at the date of grant. Any deferred compensation is recognized on a graded vesting method. Under our plan, stock options are generally granted at fair market value.

In accordance with the provisions of SFAS 123, we apply APB 25 and related interpretations in accounting for our stock incentive plans and, accordingly, do not recognize compensation cost for options granted with exercise prices equal to or greater than fair value. If we elected to recognize compensation cost based on the fair value of the awards granted at grant date as prescribed by SFAS 123, net loss and basic and diluted net loss per share would have been adjusted as follows (in thousands, except per share amounts):

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The fair value for each award granted was estimated at the date of grant using a Black-Scholes option-pricing model, assuming no dividends and the following other assumptions:

Stock compensation expense for options granted to non-employees has been determined in accordance with SFAS 123 and the Emerging Issues Task Force, or EITF, consensus in Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. The fair value of options granted to non-employees is periodically remeasured as the underlying options vest.

5. Acquisition of Novuspharma, S.p.A.

On January 1, 2004, we completed the merger of Novuspharma, an Italian biopharmaceutical company focused on oncology, into CTI (“the Merger”). Novuspharma’s development strategy focused on the treatment of cancer, both by modifying existing chemotherapies to make them more effective and less toxic and by developing completely novel therapeutics for treatment of the disease. Following completion of the merger, Novuspharma’s assets and liabilities were contributed to our newly established European Branch, CTI (Europe).

As a closing condition to the merger, we applied and received approval for the listing of CTI common stock on the Nuovo Mercato (a segment of the Italian stock exchange) in Italy and began trading under the ticker symbol “CTIC” effective January 2, 2004.

At the time of the merger, approximately 15,629,000 shares of CTI common stock were issued based on the conversion of approximately 6,379,000 outstanding Novuspharma ordinary shares multiplied by the fixed exchange ratio of 2.45, with cash paid in lieu of fractional shares. The total cost of the merger was approximately $196,079,000, based on a fair value of CTI common stock of $12.14, the average price of our common stock during a seven-day period beginning three trading days before and ending three trading days after the public announcement of the merger (June 12, 13, 16, 17, 18, 19 and 20, 2003) and related transaction costs.

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The estimated total purchase price of the merger is as follows (in thousands):

As an asset purchase, the total estimated purchase price as shown in the table above was allocated to Novuspharma’s net tangible and intangible assets, including IPRD, based initially on their fair values as of January 1, 2004. These fair values were determined through a valuation performed by an independent third party. The estimated purchase price in excess of these estimated fair values was then allocated on a pro rata basis to IPRD and to non-monetary long-lived assets. During the quarter ended June 30, 2004, certain purchase price adjustments were made resulting in an adjustment to the original excess purchase price allocation to IPRD and non-monetary long-lived assets. Additional purchase price adjustments may occur during the last half of 2004 based on resolution of certain uncertainties related to the collection of grants receivable for services rendered by Novuspharma in 2003. IPRD represents the value of Novuspharma’s research and development projects in progress and was charged to operations upon the closing of the merger in accordance with SFAS 2, Accounting for Research and Development Costs. Other identified intangible assets with finite lives are being amortized over those lives and will be reviewed for impairment on at least an annual basis. No goodwill was recognized as a result of the Novuspharma transaction. Novuspharma’s results of operations are included in CTI’s statement of operations from January 1, 2004.

The allocation of the estimated purchase price was as follows (in thousands):

In-process research and development

Acquired IPRD for the Merger was evaluated utilizing the present value of the estimated after-tax cash flows expected to be generated by purchased technology, which, at the effective time of the Merger, had not reached technological feasibility. The cash flow projections for revenues are based on estimates of growth rates and the aggregate size of the respective market for each product, probability of technical success given the stage of development at the time of acquisition, royalty rates based on an assessment of industry market rates, product sales cycles, and the estimated life of a product’s underlying technology. The projections for revenues include assumptions that significant cash flows from product revenue would commence in 2006. Estimated operating expenses and income taxes are deducted from estimated revenue projections to arrive at estimated after-tax cash flows. Projected operating expenses include cost of goods sold, general and administrative expenses, and research and development costs. The rate utilized to discount projected cash flows was 30%, and was based on the relative risk of each in-process technology and was based primarily on risk adjusted rates of return for research and development and our weighted average cost of capital at the time of the Merger.

Acquired IPRD of approximately $88.1 million represents the values determined by our management to be attributable to the IPRD assets associated with the technology acquired in the Merger as follows (in thousands):

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As of January 1, 2004, pixantrone, also known as BBR 2778, was in Phase III clinical trials in indolent non-Hodgkin’s lymphoma, or NHL, in Phase II clinical trials in aggressive NHL, and was expected to enter clinical trials in multiple sclerosis, or MS, during the first half of 2004. The trial for indolent NHL was modified and reduced to a registration supporting study and has been subsequently discontinued based on our strategy to conduct a pivotal phase III trial in aggressive NHL. Additionally, the MS trial has been delayed due to the priority placed on the registration trials. Pixantrone produced positive results in terms of efficacy and safety in preclinical trials and in Phase I and II trials. In preclinical studies, pixantrone has shown notable activity in animal models of cancer, particularly in models of blood-born tumors such as lymphoma. For purposes of the valuation, Novuspharma estimated its future research and development costs for pixantrone to be approximately $35.8 million through the launch year. Additionally, Novuspharma expected to file a new drug application with the FDA for pixantrone in 2005, at the earliest, with an estimated launch of pixantrone for aggressive NHL in 2006, with revenues for indolent NHL and MS being generated through off label usage. However, significant risk remains relative to the uncertainties inherent in clinical trials and in ultimately obtaining regulatory approval.

The values associated with these programs represent values ascribed by CTI’s management, based on the discounted cash flows currently expected from the technologies acquired and a pro rata allocation of the purchase price in excess of the estimated fair values of non-monetary assets acquired. The estimated cash flows include the estimated development costs and estimated product launch dates referred to above with estimated lives of these products ranging from twelve to fourteen years after approval. If these projects are not successfully developed, our business, results of operations and financial condition may be adversely affected. As of the date of the Merger, we concluded that once completed, the technologies under development can only be economically used for their specific and intended purposes and that the in-process technology has no alternative future use after taking into consideration the overall objectives of the project, progress toward the objectives, and uniqueness of developments to these objectives.

Pro forma results of operations

The following table sets forth (1) the pro forma combined results of operations of CTI and CTI (Europe) for the three and six months ended June 30, 2004 and (2) the pro forma combined historical results of operations of CTI and Novuspharma for the three and six months ended June 30, 2003 as if the Merger occurred on January 1, 2003 (in thousands, except for per share amounts).

The unaudited pro forma combined financial data is not intended to represent or be indicative of our consolidated results of operations that would have been reported had the merger been completed as of the dates presented, and should not be taken as representative of our future consolidated results of operation. The pro forma results do not include the effect or the charge for IPRD as this is a non-recurring charge resulting from the acquisition.

6. Restructuring Activities

In 2003, we began to implement plans to reduce our workforce to eliminate areas of redundancy and capitalize on synergies and efficiencies expected to be created by the merger with Novuspharma. As of June 30, 2004, a total of 47 employees had been terminated or received notice of termination as a result of our restructuring activities.

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Employee separation costs associated with the reorganization consist primarily of one-time termination benefits, principally severance payments and for certain key employees include retention bonuses, and are recognized in accordance with SFAS 146, Accounting for Costs Associated with Exit and Disposal Activities. To date, we have recorded approximately $1.7 million in research and development expenses for employee termination benefits related to terminated employees, of which $181,000 was incurred during the six months ended June 30, 2004, respectively. We expect to incur additional employee termination benefit expenses of approximately $93,000 during 2004.

The following table summarizes the changes in the liability for employee separation costs during the six months ended June 30, 2004 (in thousands):

7. Prepaid Supply Agreement

In September 2001, we entered into a purchase agreement with Natural Pharmaceuticals, Inc., or NPI, to purchase $6.0 million of paclitaxel which was to be delivered by NPI over several years. We paid for the entire purchase upon execution of the agreement in 2001 and recorded the amount as a prepaid asset. We also entered into a security agreement with NPI to collateralize our prepayment with the value of the NPI owned yew trees from which paclitaxel is derived. As of June 30, 2004 we had received approximately $2.7 million of paclitaxel; however, based on the original terms of agreement, NPI was behind on its delivery of the remaining paclitaxel. In June 2004, we received a revised delivery schedule from NPI that detailed the new delivery dates through December 2005 for the remaining paclitaxel. As of June 30, 2004, our prepaid asset related to the undelivered paclitaxel was approximately $3.3 million, of which approximately $1.7 million has been classified as non-current.

8. Related Party Transactions

On April 8, 2002, we extended a loan of $3.5 million to Dr. James A. Bianco, our president and chief executive officer, which bears interest at the six-month LIBOR rate plus 2.25%, adjusted semi-annually, and was due on April 8, 2004. This loan is a full-recourse loan and is secured by a second mortgage on certain property owned by Dr. Bianco, as well as 255,381 shares of our common stock owned by Dr. Bianco. Dr. Bianco paid accrued interest on his $3.5 million loan through October 2003. The loan to Dr. Bianco was made by CTI before the passage of the Sarbanes-Oxley Act of 2002. Dr. Bianco informed the board that he would not be able to pay this loan, including accrued interest, in full when due on April 8, 2004. On April 8, 2004, in accordance with the terms of the original loan agreement, the interest rate on the loan increased by an additional 3% and as of June 30, 2004, interest receivable on the loan was approximately $112,000. The board of directors has delegated to the audit committee the responsibility of monitoring the collection of this loan. The audit committee has assessed the value of all collateral and sources of repayment for the loan, and is working with Dr. Bianco towards the promptest practical repayment of the loan. Dr. Bianco has confirmed to the board his absolute and unconditional obligation to repay the loan in full. As of June 30, 2004, based on an assessment of various factors including the estimated value of the collateral, the Company believes that the loan is fully collectible.

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9. Legal Proceedings

On February 10, 2004, Micromet AG (“Micromet”), a Munich, German-based company, filed a complaint against CTI in federal district court in the State of Washington, asserting that CTI (Europe), the Company’s European Branch (formerly known as Novuspharma S.p.A), had purportedly breached a contract with Micromet for the development of MT201, a fully human antibody targeting the EP-CAM molecule. The claims allege that CTI (Europe) failed to pay for certain milestones and development expenses owed under the contract. On February 23, 2004, the CTI answered the complaint, denying the substance of the allegations, and filed counterclaims for breach of contract and for rescission of the contract based on Micromet’s misrepresentations and failures to disclose material information which includes preclinical tests which were determined to be invalid. Management believes that Micromet’s complaint is without merit and intends to vigorously defend against the Micromet action, as well as to seek recovery based upon its counterclaims. Management believes the ultimate outcome will not have a material adverse impact on the Company’s financial condition or results of operations.

10. Subsequent Events

In August 2004, we received approximately $42.8 million in gross proceeds from a public offering of 9.0 million shares of our common stock. These shares were sold under an existing shelf registration statement filed in February 2004 at a public offering price of $4.75 per share. We also expect to incur approximately $3.4 million in expenses, including underwriters’ discounts and commissions, related to this offering.

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

This quarterly report on Form 10-Q contains, in addition to historical information, forward-looking statements which involve risks and uncertainties. These statements relate to our future plans, objectives, expectations, intentions and financial performance, and assumptions that underlie these statements. When used in this Form 10-Q, the words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” should,” or “will” or the negative of those terms or other comparable terms are intended to identify such forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause industry trends or our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Our actual results may differ significantly from the results discussed in such forward-looking statements. These factors include those listed under “Factors Affecting Our Operating Results and Financial Condition,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-Q. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events.

OVERVIEW

We develop, acquire and commercialize novel treatments for cancer. Our goal is to build a leading, vertically-integrated biopharmaceutical company with a diversified portfolio of proprietary oncology drugs. Our research, development, acquisition, and in-licensing activities are concentrated on identifying new, less toxic and more effective ways to treat cancer. As of June 30, 2004, we had incurred aggregate net losses of approximately $644.3 million since inception. We expect to continue to incur significant additional operating losses for at least the next eighteen months from our research and development efforts.

On January 1, 2004, we completed our acquisition of Novuspharma S.p.A. (currently CTI (Europe)), a public biopharmaceutical company located in Italy. We issued 15,629,138 shares of CTI common stock based on the conversion of 6,379,240 outstanding Novuspharma ordinary shares multiplied by the fixed exchange ratio of 2.45. The total cost of the merger was approximately $196.1 million. This acquisition provided us worldwide rights to pixantrone, approximately $92.5 million of cash and cash equivalents upon closing of the acquisition, and a high-quality drug discovery organization and staff with an extensive track record in cancer drug development. The acquisition of CTI (Europe) and pixantrone are consistent with our strategy of growth by strategic acquisition and our goal to develop improved cancer therapies.

XYOTAX

In June 1998, we entered into an agreement with PG-TXL Company, L.P., or PG-TXL, and scientists at The University of Texas M. D. Anderson Cancer Center, granting us an exclusive worldwide license to the rights to paclitaxel poliglumex and to all potential uses of PG-TXL’s polymer technology. Paclitaxel poliglumex is paclitaxel linked to polyglutamate, and is branded as XYOTAX^™, or XYOTAX. Under the terms of the agreement, we will fund the research, development, manufacture, marketing and sale of drugs developed using PG-TXL’s polymer technology. As of June 30, 2004, we have made $5.0 million in milestone payments upon the attainment of significant achievements and are obligated to make additional future milestone payments of up to $15.5 million and royalty payments on net product sales as defined in the agreement.

In September 2001, we entered into a supply agreement with Natural Pharmaceuticals, Inc., or NPI, for paclitaxel, a key starting material for our XYOTAX drug candidate. Under the supply agreement, we prepaid for paclitaxel. NPI is behind in its delivery schedule to us although we expect to receive delivery through 2005. We may need to obtain paclitaxel from another vendor, which we may not be able to receive on a timely basis, if at all.

In October 2001, we entered into a licensing agreement with Chugai Pharmaceutical Co., Ltd., or Chugai, for the development and commercialization of XYOTAX. This agreement grants an exclusive license to Chugai to develop and commercialize XYOTAX in several Asian markets. Upon execution of the agreement, Chugai paid us a $3.0 million initial payment, which has been recorded as deferred revenue and is being recognized as license revenue over

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the development period of approximately seven years on a straight-line basis. Under the agreement, we received and recognized as revenue a $3.0 million milestone payment during 2002, we may also receive future milestone payments totaling up to $13.0 million upon Chugai’s achievement of certain product development milestones, and we are entitled to receive royalties on product sales in the territories covered under the agreement. Chugai has also committed to incur up to $54.0 million in development expenditures over the course of the licensing agreement. As of June 30, 2004, we have received $3.4 million in development expenditure reimbursements from Chugai.

In 2002, we initiated a XYOTAX phase III clinical trial for second-line treatment of non-small cell lung cancer, or NSCLC, and two additional phase III trials of XYOTAX in the front-line treatment of poor performance status, or PS2, patients with NSCLC.

In June 2003, we received fast track designation from the FDA for our XYOTAX pivotal trials in PS2 patients with advanced NSCLC.

In November 2003, we completed enrollment in one of our XYOTAX phase III pivotal trials, known as STELLAR 3, for the potential use in combination with platinum as front-line treatment of PS2 patients with NSCLC. Based on a higher than historically predicted survival rate reported by the data monitoring committee between January and June 2004, we do not expect to reach the number of events required to perform the primary efficacy analysis of the STELLAR 3 trial until early 2005. As a result, our revised target for submission of an NDA for XYOTAX is sixteen weeks following the primary analysis in 2005.

On April 1, 2004, we announced that we entered into a clinical trials agreement with the Gynecologic Oncology Group, or GOG, to perform a phase III trial of XYOTAX in patients with ovarian cancer. In July 2004, the GOG submitted an investigational new drug application, or IND, along with the protocol for a special protocol assessment, or SPA, to the FDA. The trial is expected to begin in the second half of 2004.

In May 2004, we completed enrollment in our second pivotal phase III trial of XYOTAX, known as STELLAR 4, for the potential use as front-line single agent treatment of PS2 patients with NSCLC.

In July 2004, we completed enrollment in our third and final pivotal phase III trial of XYOTAX, known as STELLAR 2, for the potential use as second-line single agent treatment of patients with NSCLC.

TRISENOX

On January 7, 2000, we entered into a Merger Agreement to acquire PolaRx Biopharmaceuticals, Inc., or PolaRx, a biopharmaceutical company that owned the rights to TRISENOX, an anti-cancer compound for which we submitted and received approval for an NDA with the FDA. The acquisition was accounted for as a purchase transaction.

In September 2000, we received marketing approval of our NDA by the FDA for TRISENOX and sales of TRISENOX in the U.S. commenced in October 2000. In March 2002, we received approval from the EMEA to market TRISENOX in the European Union, or EU and we commenced the launch and sale of TRISENOX in the EU during the second quarter of 2002.

During 2002, we met a $10.0 million TRISENOX sales threshold, which triggered an additional payment of approximately $4.0 million to PolaRx shareholders under the terms of the Merger Agreement. We also recorded $5.0 million in additional goodwill and an accrued liability during the fourth quarter of 2003 in connection with achieving a $20.0 million sales threshold during the year, which was paid out during the first half of 2004. We are also required to make an additional payout of a 2% royalty on total net sales, payable in cash or common stock at the then fair market of our stock, for any calendar year that sales of TRISENOX exceed $40.0 million.

We have recorded cumulative net product sales for TRISENOX of approximately $51.9 million through June 30, 2004. TRISENOX is manufactured primarily by a single vendor and sold through our direct sales force.

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In December 2002, we entered into a distribution agreement with Nippon Shinyaku Co. Ltd., or Nippon. This agreement grants an exclusive license to Nippon to market and distribute TRISENOX injection in Japan, South Korea, and Taiwan. Upon execution of the agreement, Nippon paid us a $750,000 initial payment, which we recorded as deferred revenue and which is being recognized as revenue over the performance period of approximately eighteen months on a straight-line basis. Under the agreement, we received and recognized as revenue a $500,000 milestone payment from Nippon in 2003 and we may also receive additional future milestone payments totaling up to $3.5 million upon attainment of certain achievements. We anticipate approval of TRISENOX for relapsed acute promyelocytic leukemia, or APL, in Japan in the fourth quarter of 2004 which will trigger an additional milestone payment of $500,000 to us.

In April 2004, the U.S. Patent and Trademark office issued a patent directed to TRISENOX injection that extends CTI’s market exclusivity in the U.S. for the drug from 2007 to 2018. This extension is eleven years beyond the original orphan drug exclusivity for APL that currently expires in 2007.

We have recently refocused our TRISENOX development efforts to approximately 40 clinical and investigator-sponsored trials, with an emphasis on blood-related cancers, including front-line APL and multiple myeloma.

PIXANTRONE

We acquired pixantrone, a novel compound, for the potential treatment of non-Hodgkin’s lymphoma, or NHL, through our merger with Novuspharma S.p.A. in January 2004. We are developing pixantrone, and have several clinical trials ongoing, including a pivotal phase III trial for the potential treatment of relapsed aggressive NHL. In phase I/II clinical trials alone and in combination, pixantrone has demonstrated good responses and has been well tolerated, with a low rate of cardiac side effects. In July 2004, we announced that the FDA granted fast track designation for Pixantrone for the potential treatment of relapsed aggressive NHL on the basis that relapsed aggressive NHL in the third-line or subsegment recurrence is a life threatening disease and responses have been noted in phase II trials with patients with relapsed, aggressive NHL.

OTHER COMPOUNDS

We are developing a novel polyglutamate-camptothecin molecule, or CT-2106. We filed an IND in December 2001 for this compound and initiated a phase I clinical study in the first quarter of 2002. In April 2004, we initiated a phase I/II clinical trial of CT-2106 in combination with infusional 5 fluorouracil/folinic acid, or 5-FU/FA, in patients with metastatic colorectal cancer who have failed front-line therapy with oxaliplatinum. We plan to initiate clinical studies of CT-2106 in small cell lung cancer and advanced ovarian cancer during 2005.

Critical Accounting Policies and Estimates

Management makes certain judgments and uses certain estimates and assumptions when applying accounting principles generally accepted in the United States in the preparation of our consolidated financial statements. We evaluate our estimates and judgments on an on-going basis and base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate and different assumptions or estimates about the future could change our reported results. We believe the following accounting policies are the most critical to us, in that they are important to the portrayal of our consolidated financial statements and require our most difficult, subjective or complex judgments in the preparation of our consolidated financial statements.

Product Sales

We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, title has passed and delivery has occurred, the price is fixed and determinable, and collectibility is reasonably assured. Product sales are recorded net of an allowance for estimated returns and discounts. Customers may return damaged or expired inventory up to twelve months after the expiration date. In estimating returns, we analyze historical returns, sales patterns, estimated inventory on hand at the distributors and the remaining shelf life of that inventory. In arriving at the accrual for product returns we match the returns to the corresponding production batch to assess the historical trend for returns. Based on this analysis, the estimated return percentage is applied to current period sales. Allowances for returns, discounts and bad debts are netted against accounts receivable.

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License Agreement Revenues

We may generate revenue from technology licenses, collaborative research and development arrangements, and cost reimbursement contracts. Revenue under technology licenses and collaborative agreements typically consists of nonrefundable and/or guaranteed technology license fees, collaborative research funding, and various milestone and product royalty or profit-sharing payments.

Revenue associated with up-front license fees, and research and development funding payments under collaborative agreements is recognized ratably over the relevant periods specified in the agreement, generally the research and development period. If the time period is not defined in the agreement, we calculate the revenue recognition period based on our current estimate of the research and development period considering experience with similar projects, level of effort and the stage of development. Should there be a change in our estimate of the research and development period, we will revise the term over which the initial payment is recognized. Revenue from substantive at-risk milestones and future product royalties is recognized as earned based on the completion of the milestones and product sales, as defined in the respective agreements. Revenue under cost reimbursement contracts is recognized as the related costs are incurred. Payments received in advance of recognition as revenue are recorded as deferred revenue.

In November 2002, the Emerging Issues Task Force issued EITF 00-21, Revenue Arrangements with Multiple Deliverables, which addresses certain aspects of the accounting for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. Under EITF 00-21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables meet certain criteria, including whether the delivered items have a stand-alone value for the customer and whether there is evidence of fair value of the undelivered items. In addition, the total consideration should be allocated among the separate units of accounting based on their fair values and the applicable revenue recognition criteria should be considered separately for each of the separate units of accounting. We have adopted EITF 00-21 as of July 1, 2003, and will apply its provisions for all revenue arrangements we enter into on or after this date. The adoption of EITF 00-21 did not have a material impact on our revenue recognition accounting policies, financial position or result of operations. We will continue to evaluate the impact of EITF 00-21 as we enter into new revenue arrangements in the future.

Inventory

Inventory is stated at the lower of cost or market. Cost is determined using a weighted-average method. Finished goods inventory consists of our FDA and EMEA approved pharmaceutical drug, TRISENOX. We also record an allowance for inventory that may expire and become unsaleable due to the expiration of shelf life. In estimating inventory obsolescence reserves, we analyze (i) the shelf life and the expiration date, (ii) sales forecasts and (iii) inventory levels compared to forecasted usage. Judgment is required in determining whether the forecasted sales and usage information is sufficiently reliable to enable us to estimate inventory obsolescence reserve.

Research and Development Expenses

Research and development expenses include related salaries and benefits, clinical trial and related clinical manufacturing costs, contract and other outside service fees, and facilities and overhead costs. Research and development expenses consist of costs incurred for proprietary and collaboration research and development and also include activities such as product registries and investigator sponsored trials. Research and development costs are expensed as incurred. In instances where we enter into agreements with third parties for research, clinical trial, and related clinical trial manufacturing costs, costs are expensed upon the earlier of when non-refundable amounts are due or as services are performed. Amounts due under such arrangements may be either fixed fee or fee for service, and may include upfront payments, monthly payments, and payments upon the completion of milestones or receipt of deliverables.

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Derivative Financial Instruments

We are subject to risks associated with fluctuations in the LIBOR interest rate from lease payments on our leased aircraft. Our policy is to hedge a portion of these forecasted transactions through an interest rate swap agreement. This swap agreement has been designated as a cash flow hedge. The portion of the net gain or loss on the derivative instrument that is effective as a hedge is reported as a component of accumulated other comprehensive loss in shareholders’ deficit and is reclassified into earnings in the same period during which the hedged transaction affects earnings. The remaining net gain or loss on the derivative in excess of the present value of the expected cash flows of the hedged transaction is recorded in earnings immediately. If a derivative does not qualify for hedge accounting, or a portion of the hedge is deemed ineffective, the change in fair value is recorded in earnings. The swap was perfectly effective at June 30, 2004 and December 31, 2003. We do not enter into forward agreements for trading purposes.

Purchase Price Allocation

The purchase price for Novuspharma S.p.A. was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date of January 1, 2004. An independent third-party valuation firm was engaged to assist in determining the fair values of in-process research and development, and identifiable intangible assets. Such a valuation requires significant estimates and assumptions including but not limited to: determining the timing and expected costs to complete the in-process projects, projecting regulatory approvals, estimating future cash flows from product sales resulting from in-process projects, and developing appropriate discount rates and probability rates by project. We believe the fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions. However, these assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Additionally, estimates for the purchase price allocation may change as subsequent information becomes available.

RESULTS OF OPERATIONS

Three months ended June 30, 2004 and 2003.

Product sales. TRISENOX is our pharmaceutical grade arsenic product that has been approved by the FDA and EMEA to treat patients with relapsed or refractory APL. We recorded net product sales of approximately $7.9 million and $5.3 million for TRISENOX for the three months ended June 30, 2004 and 2003, respectively. The increase in net sales is primarily due to a greater demand for our product, including an increase in sales in Europe due to an expansion of our European sales force.

License and contract revenue. In October 2001, we entered into a licensing agreement with Chugai Pharmaceutical Co., Ltd., or Chugai, for the development and commercialization of XYOTAX. Upon execution of the agreement, Chugai paid us a $3.0 million initial payment, which we recorded as deferred revenue and which is being recognized as revenue over the estimated development period of approximately seven years on a straight-line basis. In December 2002, we entered into a distribution agreement with Nippon Shinyaku Co., Ltd., or Nippon, for the distribution and commercialization of TRISENOX. We received $750,000 upon execution of the agreement which we recorded as deferred revenue and which is being recognized as revenue over the performance period of approximately two years on a straight-line basis.

For the three months ended June 30, 2004, we recognized approximately $0.4 million of license and contract revenue, of which approximately $0.2 million related to the amortization of the initial payments from Chugai and Nippon and approximately $0.2 million related to cost reimbursements for development expenses received from Chugai. For the three months ended June 30, 2003, we recognized approximately $0.8 million of license and contract revenue, of which $0.5 million related to a milestone payment received from Nippon for their submission of an NDA in Japan, approximately $0.2 million related to the amortization of the initial payments from Chugai and Nippon and approximately $0.1 million related to cost reimbursements for development expenses received from Chugai.

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Cost of product sold. The cost of product sold during the three months ended June 30, 2004 and 2003 was approximately $276,000 and $252,000, respectively. Our gross margins have remained consistent over the periods. Cost of product sold consists primarily of manufacturing costs, allowances for excess inventory that may expire and become unsaleable, and royalties paid on product sales. We expect product costs in the future to continue to approximate a small percentage of product sales.

Research and development expenses. Our research and development expenses for compounds under development and discovery research are as follows (in thousands):

Costs for compounds under development include external direct expenses such as principal investigator fees, clinical research organization charges and contract manufacturing fees incurred for preclinical, clinical, manufacturing and regulatory activities associated with preparing the compounds for submissions of new drug applications to the FDA, EMEA or similar regulatory filings with agencies outside the U.S. Operating costs include our personnel and occupancy expenses associated with developing these compounds. Discovery research costs include primarily personnel, occupancy, and laboratory expenses associated with the discovery and identification of new drug targets and lead compounds. We do not allocate operating costs to the individual compounds under development as our accounting system does not track these costs by individual compound. As a result, we are not able to capture the total cost of each compound. Direct external costs incurred to date for XYOTAX, TRISENOX and pixantrone are $131.5 million, $21.0 million and $3.9 million, respectively. Costs for pixantrone prior to our merger with Novuspharma in January 2004 are excluded from this amount.

Research and development expenses increased to approximately $23.8 million for the three months ended June 30, 2004, from approximately $22.0 million for the three months ended June 30, 2003. This increase is primarily related to higher operating expenses associated with our newly acquired CTI (Europe) operations offset by decreased expenses related to XYOTAX development. Costs for our XYOTAX program decreased primarily due to advanced purchases of comparator drugs in 2003 which were used for our phase III clinical trials and other clinical trials. Costs for pixantrone during the three months ended June 30, 2004 resulted from our acquisition of pixantrone through the merger with Novuspharma; these costs were incurred by Novuspharma in the previous year. TRISENOX costs decreased approximately $0.2 million primarily due to a decrease in investigator sponsored trials. The increase in operating expenses primarily related to costs associated with CTI (Europe) operations as well as increased personnel and occupancy costs. Costs for discovery research decreased primarily as a result of the dissolution of PanGenex during the first quarter of 2004 and decreased personnel and occupancy costs associated with the termination of certain employees in connection with our merger with Novuspharma offset by $0.6 million in discovery research costs incurred by CTI (Europe). We anticipate increased research and development expenses during 2004 in connection with our clinical development plans for XYOTAX, pixantrone, TRISENOX and our other products. Research and development costs may also increase as a result of restructuring charges to be incurred in connection with our plan to vacate certain excess laboratory facilities within the next year due to our integration with Novuspharma.

Our lead drug candidates, XYOTAX, pixantrone and TRISENOX for indications other than relapsed or refractory APL, are currently in clinical trials. Many drugs in human clinical trials fail to demonstrate the desired safety and efficacy characteristics. Even if our drugs progress successfully through initial human testing, they may fail in later stages of development. A number of companies in the pharmaceutical industry, including us, have

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suffered significant setbacks in advanced clinical trials, even after reporting promising results in earlier trials. Regulatory agencies, including the FDA and EMEA, regulate many aspects of a product candidate’s life cycle, including research and development and pre-clinical and clinical testing. We or regulatory authorities may suspend clinical trials at any time on the basis that the participants are being exposed to unacceptable health risks. Completion of clinical trials depends on, among other things, the number of patients available for enrollment in a particular trial, which is a function of many factors, including the availability and proximity of patients with the relevant condition. We rely on third parties to conduct clinical trials, which may result in delays or failure to complete trials if the third parties fail to perform or meet applicable standards. Many of our drug candidates are still in research and preclinical development, which means that they have not yet been tested on humans. We will need to commit significant time and resources to develop these and additional product candidates.

Our products will be successful only if:

We will be dependent on the successful completion of these goals in order to generate revenues. The failure to generate such revenues may preclude us from continuing our research and development of these and other product candidates. We also enter into collaboration agreements for the development and commercialization of our product candidates. We cannot control the amount and timing of resources our collaborators devote to product candidates, which may also result in delays in the development or marketing of products.

Because of these risks and uncertainties, we cannot accurately predict when or whether we will successfully complete the development of our product candidates or the ultimate product development cost. Based on our current development plans, we anticipate launching XYOTAX for the potential treatment of NSCLC in 2005. If this launch is successful, we would expect to receive significant cash inflows in late 2005 or early 2006 from this compound. Based on development plans for pixantrone, we expect to have interim data from the phase III trial in 2005 and if successful we intend to file an NDA for pixantrone in late 2005 or early 2006, with an estimated launch date of pixantrone for the potential treatment of aggressive NHL in 2006. If this launch is successful, significant cash inflows are expected in 2006.

With the exception of TRISENOX, we anticipate that we will not generate revenue from the sale of commercial drugs for approximately eighteen months, if ever. Without revenue generated from commercial sales, we anticipate that funding to support our ongoing research, development and general operations will primarily come from public or private equity financings, collaborations, milestones and licensing opportunities from current or future collaborators.

Selling, general and administrative expenses. Selling, general and administrative expenses increased to approximately $19.8 million for the three months ended June 30, 2004, from approximately $12.8 million for the three months ended June 30, 2003. This increase is primarily attributed to additional sales and marketing costs of approximately $2.4 million mainly related to our expanded commercialization efforts of TRISENOX in both the US and EU, approximately $1.5 million of costs related to CTI (Europe) operations, an increase of approximately $1.1 million in operating, personnel and occupancy costs associated with supporting our research, development and marketing activities, increased corporate development expenses of approximately $0.8 million, approximately $0.7 million in additional stock-based compensation charges, and approximately $0.5 million in increased finance and administration charges of which $0.3 million related to costs associated with Sarbanes-Oxley compliance work. Corporate development expenses include certain legal expenses, certain business development activities, costs related to operating our aircraft, and our corporate communications programs. We expect selling, general and administrative expenses to increase in the future to support our expected increase in research, development and

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commercialization efforts. Additionally, due to the variable accounting treatment of certain stock options, fluctuations in quoted prices for our common stock may result in unpredictable and potentially significant charges or credits to our stock-based compensation.

Acquired in-process research and development. Acquired in-process research and development relates to a one-time non-cash charge recorded in connection with our acquisition of Novuspharma in January 2004. The credit recorded in the three months ended June 30, 2004 relates to purchase price adjustments made during the quarter. Additional purchase price adjustments may occur during the last half of 2004 based on resolution of certain uncertainties related to the collection of grants receivable for services rendered by Novuspharma in 2003.

Amortization of purchased intangibles. Amortization for the three months ended June 30, 2004 increased to approximately $569,000 from approximately $333,000 for the three months ended June 30, 2003, due to amortization of assembled workforce acquired as part of the acquisition of Novuspharma in January 2004.

Investment and other income. Investment and other income decreased to approximately $364,000 for the three months ended June 30, 2004 from approximately $451,000 for the three months ended June 30, 2003. This decrease is primarily due to a lower average securities available-for-sale balance and lower prevailing interest rates on our investments during the three months ended June 30, 2004 compared to the three months ended June 30, 2003.

Interest and other expense. Interest and other expense increased to approximately $2.7 million for the three months ended June 30, 2004 from approximately $1.9 million for the three months ended June 30, 2003. The increase is primarily due to the issuance of $75.0 million of our 4% convertible senior subordinated notes in June 2003.

Foreign exchange gain. We recognize foreign currency exchange gains and losses primarily due to the fluctuation in the value of the U.S. dollar versus the euro, and to a lesser extent, versus other currencies. The exchange gain for the three months ended June 30, 2004 is due to a fluctuation in foreign currency exchange rates, primarily related to U.S. dollar investments held by CTI (Europe). There were no significant foreign currency transaction gains or losses during the three months ended June 30, 2003.

Six months ended June 30, 2004 and 2003.

Product sales. We recorded net product sales of approximately $11.8 million and $9.6 million for TRISENOX for the six months ended June 30, 2004 and 2003, respectively. The increase in net sales during 2004 is due to an increase in sales price as well as an increase in demand in both Europe and the U.S. The demand for our product during the first part of 2004 was affected by a technical error made by Center for Medicare Services, or CMS, stating a payment rate of $2.81/mg for TRISENOX when administered in a physician’s office versus the correct rate of $32.94/mg. This delayed physicians and patients from receiving accurate approved reimbursement for the product. Following several inquiries from our congressional delegates regarding the CMS error, the correct payment rate was published in early February 2004. We also had additional wholesaler purchases in the fourth quarter of 2003 resulting from an anticipated price increase that occurred in December 2003 which resulted in lower sales in the first part of 2004. Given sales levels during the second quarter, we expect our net sales to continue to increase during 2004.

License and contract revenue. For the six months ended June 30, 2004, we recognized approximately $1.0 million of license and contract revenue, of which approximately $0.4 million related to the amortization of the initial payments from Chugai and Nippon and approximately $0.6 million related to cost reimbursements for development expenses received from Chugai. For the six months ended June 30, 2003, we recognized approximately $1.4 million of license and contract revenue, of which approximately $0.5 million related to the amortization of the initial payments from Chugai and Nippon, $0.5 million related to a milestone payment received from Nippon for their submission of an NDA in Japan, and approximately $0.4 million related to cost reimbursements for development expenses received from Chugai.

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Cost of product sold. The cost of product sold during the six months ended June 30, 2004 and 2003 was approximately $428,000 and $398,000, respectively. Our gross margins have remained consistent over the periods. Cost of product sold consists primarily of manufacturing costs, allowances for excess inventory that may expire and become unsaleable, and royalties paid on product sales. We expect product costs in the future to continue to approximate a small percentage of product sales.

Research and development expenses. Our research and development expenses for compounds under development and discovery research are as follows (in thousands):

Research and development expenses increased to approximately $52.7 million for the six months ended June 30, 2004, from approximately $42.7 million for the six months ended June 30, 2003. This increase is primarily related to higher operating expenses associated with our newly acquired CTI (Europe) operations offset by decreased expenses related to XYOTAX development. Costs for our XYOTAX program decreased primarily due to a decrease in manufacturing expenses which consisted mainly of a $3.4 million decrease related to advanced purchases of comparator drugs in 2003 which were used for our phase III clinical trials and other clinical trials offset by an increase in clinical expenses, including a $1.5 million increase related to an upfront payment to the GOG in connection with a clinical trials agreement entered into during March 2004 as well as additional costs associated with the execution of our three phase III clinical trials. Costs incurred for pixantrone during the first half of 2004 resulted from our acquisition of pixantrone through the merger with Novuspharma; these costs were incurred by Novuspharma in the previous year. TRISENOX costs increased approximately $0.5 million primarily as a result of an increase in investigator sponsored trials and regulatory activities. The increase in operating expenses primarily related to costs associated with CTI (Europe) operations as well as increased personnel and occupancy costs. Costs for discovery research decreased primarily as a result of the dissolution of PanGenex during the first quarter of 2004 and decreased personnel and occupancy costs associated with the termination of certain employees in connection with our merger with Novuspharma offset by approximately $1.1 million in discovery research costs incurred by CTI (Europe).

Selling, general and administrative expenses. Selling, general and administrative expenses increased to approximately $39.9 million for the six months ended June 30, 2004, from approximately $25.8 million for the six months ended June 30, 2003. This increase is primarily attributed to additional sales and marketing costs of approximately $4.6 million related to our expanded commercialization efforts of TRISENOX in both the US and EU, approximately $2.8 million of costs related to our CTI (Europe) operations, approximately $2.4 million in stock-based compensation charges, approximately $2.1 million of additional operating, personnel and occupancy costs associated mainly with supporting our research, development and marketing activities, approximately $1.2 million in increased corporate development expenses and approximately $0.6 million in increased finance and administration charges of which $0.3 million related to costs associated with Sarbanes-Oxley compliance work.

Acquired in-process research and development. Acquired in-process research and development relates to a one-time non-cash charge recorded in connection with our acquisition of Novuspharma in January 2004. This balance represents the estimated fair value of purchased technology that had not reached technological feasibility at the effective time of the merger.

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Amortization of purchased intangibles. Amortization for the six months ended June 30, 2004 increased to approximately $1.1 million from approximately $0.7 million for the six months ended June 30, 2003, due to amortization of assembled workforce acquired as part of the acquisition of Novuspharma in January 2004.

Investment and other income. Investment and other income decreased to approximately $0.9 for the six months ended June 30, 2004 from approximately $1.1 million for the six months ended June 30, 2003. This decrease is attributed to a lower average securities available-for-sale balance and lower prevailing interest rates on our investments during the six months ended June 30, 2004 compared to the six months ended June 30, 2003.

Interest and other expense. Interest and other expense increased to approximately $5.4 million for the six months ended June 30, 2004 from approximately $3.8 million for the six months ended June 30, 2003. The increase is primarily due to the issuance of $75.0 million of our 4% convertible senior subordinated notes in June 2003.

Foreign exchange gain. We recognize foreign currency exchange gains and losses primarily due to the fluctuation in the value of the U.S. dollar versus the euro, and to a lesser extent, versus other currencies. The exchange gain for the six months ended June 30, 2004 is due to a fluctuation in foreign currency exchange rates. There were no significant foreign currency transaction gains or losses during the six months ended June 30, 2003.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2004, we had approximately $89.7 million in cash, cash equivalents, securities available-for-sale and interest receivable.

Net cash used in operating activities increased to approximately $80.6 million during the six months ended June 30, 2004, compared to approximately $53.5 million for the same period during 2003. The increase in net cash used in operating activities during the six months ended June 30, 2004, as compared to the same period in 2003, was primarily due to the increase in our net loss excluding a non-cash charge related to acquired in-process research and development resulting from our acquisition of Novuspharma.

We expect the amount of net cash used in operating activities in 2004 to increase over the amount of net cash used in 2003 due to our acquisition of Novuspharma in addition to anticipated progress in our phase III clinical trials for XYOTAX and pixantrone and phase II clinical trials for both pixantrone and CT-2106. The extent of cash flow used in operating activities will be significantly affected by our ability to in-license or acquire rights to other products, or increase TRISENOX sales.

Net cash provided by investing activities totaled approximately $159.5 million during the six months ended June 30, 2004, compared to approximately $30.1 million for the same period during 2003. The increase in net cash provided by investing activities during the six months ended June 30, 2004, as compared to the same period in 2003, was primarily due to cash acquired through our acquisition of Novuspharma in January 2004 and a decrease in purchases of securities available-for-sale offset by a decrease in proceeds from maturities of securities available-for-sale.

Net cash used in financing activities totaled approximately $0.1 million during the six months ended June 30, 2004, compared to net cash provided by financing activities of approximately $72.3 million for the same period during 2003. The decrease in net cash provided by financing activities was primarily due to the net proceeds of $72.7 million we received in June 2003 from the issuance of $75.0 million of 4% convertible senior subordinated notes due July 1, 2010.

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In August 2004, we received approximately $42.8 million in gross proceeds from a public offering of 9.0 million shares of our common stock. These shares were sold under an existing shelf registration statement filed in February 2004 at a public offering price of $4.75 per share. We expect to incur approximately $3.4 million in expenses, including underwriters’ discounts and commissions, related to this offering.

We have identified a number of program deferrals in an effort to reduce expenses in the second half of 2004 to conserve capital in anticipation of the potential XYOTAX launch in 2005. These include delaying some clinical trials and deferring initiation of other clinical studies that do not significantly affect the XYOTAX or pixantrone Phase III timing. We also plan to reduce our anticipated general and administrative and travel-related expenses.

We expect to generate losses from operations for at least the next eighteen months due to substantial additional research and development costs, including costs related to clinical trials, increased sales and marketing expenditures and costs associated with the integration of CTI (Europe) into CTI. We expect that our existing capital resources, including proceeds from our recent common stock offering and taking into account the deferrals discussed above, will enable us to maintain our current operations through the first quarter of 2005; however, to fully fund ongoing and planned activities, we believe we will need to raise additional funds through equity financings, partnerships or other sources. In addition, our future capital requirements will depend on many factors, including:

Future capital requirements will also depend on the extent to which we acquire or invest in businesses, products and technologies. If we should require additional financing, such financing may not be available when needed or, if available, we may not be able to obtain it on terms favorable to us or to our shareholders. Insufficient funds may require us to delay, scale back or eliminate some or all of our research and development programs, or may adversely affect our ability to operate as a going concern. If additional funds are raised by issuing equity securities, substantial dilution to existing shareholders may result.

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The following table includes information relating to our contractual obligations as of June 30, 2004 (in thousands):

The remaining amount of milestone payments we may be required to pay pursuant to the agreement with PG-TXL Company L.P. is $15.5 million. We may also be required to make an additional payout in future years based on a 2% royalty on total net sales, payable in cash or common stock at the then fair market value of our stock, related to the PolaRx acquisition contingent upon achieving sales of TRISENOX in excess of $40 million for any calendar year.

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Risk Factors

Factors Affecting Our Operating Results and Financial Condition

This quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this quarterly report on Form 10-Q.

The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties that we do not presently know or that we currently deem immaterial may also impair our business, financial condition, operating results and prospects. If any of the following risks actually occur, they could materially adversely affect our business, financial condition, operating results or prospects. In that case, the trading price of our securities could decline.

We expect to continue to incur net losses, and we might never achieve profitability.

We were incorporated in 1991 and have incurred a net operating loss every year. As of June 30, 2004, we had an accumulated deficit of approximately $644.3 million. We may never become profitable, even if we are able to commercialize additional products. We will need to conduct significant research, development, testing and regulatory compliance activities that, together with projected general and administrative expenses, we expect will result in substantial increasing operating losses for at least the next eighteen months. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

If we do not successfully develop additional products, we may be unable to generate significant revenue or become profitable.

We have only one product, TRISENOX, for relapsed or refractory APL that has received marketing approval to date. Our leading drug candidates, TRISENOX for other indications, XYOTAX, pixantrone and CT-2106, are currently in clinical trials and may not be successful. Even if our drugs progress successfully through initial human testing, they may fail in later stages of development. Many drugs in human clinical trials fail to demonstrate the desired safety and efficacy characteristics. A number of companies in the pharmaceutical industry, including us, have suffered significant setbacks in advanced clinical trials, even after reporting promising results in earlier trials. For example, in our first phase III human trial for lisofylline, completed in March 1998, we failed to meet our two primary endpoints, or goals, even though we met our endpoints in two earlier phase II trials for lisofylline. Many of our drug candidates are still in research and pre-clinical development, which means that they have not yet been tested on humans. We will need to commit significant time and resources to develop these and additional product candidates. Our product candidates will be successful only if:

We are dependent on the successful completion of these goals in order to generate revenues. The failure to generate such revenues may preclude us from continuing our research and development of these and other product candidates.

We may need to raise additional funds in the future, and they may not be available on acceptable terms, or at all.

We expect that our existing capital resources, including the proceeds from our recent offering, will enable us to maintain our currently planned operations through the first quarter of 2005; however, to fully fund ongoing and

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planned activities, especially if one of our trials regarding XYOTAX is successful, we will need to raise additional funds. We expect to receive certain grants and subsidized loans from the Italian government and the EU through our Italian branch. However, we may not receive the relevant funding because the grants and subsidiaries are awarded at the discretion of relevant authorities.

If our plans or assumptions change or are inaccurate, it will affect the amount of additional funds we will need to raise to continue the development of our technologies and complete the commercialization of products, if any, resulting from our technologies. We may raise such capital through public or private equity financings, partnerships, debt financings, bank borrowings or other sources. Additional funding may not be available on favorable terms or at all. If adequate funds are not otherwise available, we may curtail operations significantly, including the delay, modification or cancellation of research and development programs aimed at bringing new products to market. To obtain additional funding, we may need to enter into arrangements that require us to relinquish rights to certain technologies, drug candidates, products and/or potential markets. To the extent that additional capital is raised through the sale of equity, or securities convertible into equity, you may experience dilution of your proportionate ownership of us.

Our operations in Italy make us subject to increased risk regarding currency exchange rate fluctuations.

As a result of our merger with Novuspharma and our consequent operations in Italy, we are exposed to risks associated with foreign currency transactions insofar as we might desire to use U.S. dollars to make contract payments denominated in Euros or vice versa. As the net positions of our foreign currency transactions might fluctuate, our earnings might be negatively affected. In addition, as a result of our merger with Novuspharma, we are exposed to risks associated with the translation of Novuspharma’s Euro-denominated financial results and balance sheet into United States dollars. Our reporting currency will remain as the United States dollar, however, a portion of our consolidated financial obligations will arise in Euros. In addition, the carrying value of some of our assets and liabilities will be affected by fluctuations in the value of the United States dollar as compared to the Euro. Changes in the value of the United States dollar as compared to the Euro might have an adverse effect on our reported results of operations and financial condition.

We may take longer to complete our clinical trials than we expect, or we may not be able to complete them at all.

Before regulatory approval for any potential product can be obtained, we must undertake extensive clinical testing on humans to demonstrate the safety and efficacy of the product. Although for planning purposes we forecast the commencement and completion of clinical trials, the actual timing of these events can vary dramatically due to a number of factors.

We may not obtain authorization to permit product candidates that are already in the pre-clinical development phase to enter the human clinical testing phase. Authorized pre-clinical or clinical testing may not be completed successfully within any specified time period by us, or without significant additional resources or expertise to those originally expected to be necessary. Many drugs in human clinical trials fail to demonstrate the desired safety and efficacy characteristics. Clinical testing may not show potential products to be safe and efficacious and potential products may not be approved for a specific indication. Further, the results from pre-clinical studies and early clinical trials may not be indicative of the results that will be obtained in later-stage clinical trials. Data obtained from clinical trials are susceptible to varying interpretations. Government regulators and our collaborators may not agree with our interpretation of our future clinical trial results. In addition, we or regulatory authorities may suspend clinical trials at any time on the basis that the participants are being exposed to unacceptable health risks or for other reasons. Completion of clinical trials depends on, among other things, the number of patients available for enrollment in a particular trial, which is a function of many factors, including the number of patients with the relevant conditions, the nature of the clinical testing, the proximity of patients to clinical testing centers, the eligibility criteria for tests as well as competition with other clinical testing programs involving the same patient profile but different treatments.

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We have limited experience in conducting clinical trials. We expect to continue to rely on third parties, such as contract research organizations, academic institutions and/or co-operative groups, to conduct, oversee and monitor clinical trials as well as to process the clinical results and manage test requests, which may result in delays or failure to complete trials, if the third parties fail to perform or to meet the applicable standards.

If we fail to commence or complete, or experience delays in any of our present or planned clinical trials, including the Phase III clinical trials of XYOTAX, the Phase II clinical trials of TRISENOX and the Phase II and Phase III clinical trials of pixantrone, our ability to conduct our business as planned could be harmed. Our development costs may increase if we experience any future delays in our clinical trials for XYOTAX, TRISENOX, pixantrone or our other product candidates or if we need to perform more or larger clinical trials than planned. If delays or costs are significant, our financial results and our ability to commercialize our product candidates may be adversely affected.

Even if our drug candidates are successful in clinical trials, we may not be able to successfully commercialize them.

Since our inception in 1991, we have dedicated substantially all of our resources to the research and development of our technologies and related compounds. With the exception of TRISENOX for patients with APL who have relapsed or failed standard therapies, all of our compounds currently are in research or development, and none has been submitted for marketing approval.

Prior to commercialization, each product candidate requires significant additional research, development and pre-clinical testing and extensive clinical investigation before submission of any regulatory application for marketing approval. The development of anti-cancer drugs, including those we are currently developing, is unpredictable and subject to numerous risks. Potential products that appear to be promising at early stages of development may not reach the market for a number of reasons including that they may:

The occurrence of any of these events could adversely affect the commercialization of our products. Products, if introduced, may not be successfully marketed and/or may not achieve customer acceptance. If we fail to commercialize products or if our future products do not achieve significant market acceptance, we will not likely generate significant revenues or become profitable.

If any of our license agreements for intellectual property underlying TRISENOX, XYOTAX, pixantrone or any other products are terminated, we may lose our rights to develop or market that product.

We have licensed intellectual property, including patent applications from The Memorial Sloan-Kettering Cancer Center, Samuel Waxman Cancer Research Foundation, Dr. Daopei Lu of the Beijing Medical University, The University of Vermont, Hoffman La Roche and others, including the intellectual property relating to TRISENOX, other arsenic applications or pixantrone. We have also in-licensed the intellectual property relating to our drug delivery technology that uses polymers that are linked to drugs, known as polymer-drug conjugates, including XYOTAX and CT-2106. Some of our product development programs depend on our ability to maintain

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rights under these licenses. Each licensor has the power to terminate its agreement with us if we fail to meet our obligations under these licenses. We may not be able to meet our obligations under these licenses. If we default under any license agreements, we may lose our right to market and sell any products based on the licensed technology.

If we fail to establish and maintain collaborations or if our partners do not perform, we may be unable to develop and commercialize our product candidates.

We have entered into collaborative arrangements with third parties to develop and/or commercialize product candidates and are currently seeking additional collaborations. For example, we have entered into an agreement with Chugai Pharmaceutical Co., Ltd. to develop and commercialize XYOTAX in several Asian markets. Additional collaborations might be necessary in order for us to fund our research and development activities and third-party manufacturing arrangements, seek and obtain regulatory approvals and successfully commercialize our existing and future product candidates. If we fail to enter into additional collaborative arrangements or fail to maintain our existing collaborative arrangements, the number of product candidates from which we could receive future revenues would decline.

Our dependence on collaborative arrangements with third parties will subject us to a number of risks that could harm our ability to develop and commercialize products, including that:

The occurrence of any of these events could adversely affect the development or commercialization of our products.

Because we base several of our drug candidates on unproven novel technologies, we may never develop them into commercial products.

We base many of our product candidates upon novel delivery technologies that we are using to discover and develop drugs for the treatment of cancer. These technologies have not been proven. Furthermore, pre-clinical results in animal studies may not predict outcomes in human clinical trials. Our product candidates may not be proven safe or effective. If these technologies do not work, our drug candidates may not develop into commercial products.

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We may face difficulties in achieving acceptance of our products in the market if we do not continue to expand our sales and marketing infrastructure.

We currently are marketing TRISENOX with our direct sales force. Competition for these individuals is intense, and in the event we need additional sales personnel, we may not be able to hire individuals with the experience required or number of sales personnel we need. In addition, if we market and sell products other than TRISENOX, we may need to further expand our marketing and sales force with sufficient technical expertise and distribution capacity. If we are unable to expand our direct sales operations and train new sales personnel as rapidly as necessary, we may not be able to increase market awareness and sales of our products, which may prevent us from growing our revenues and achieving and maintaining profitability.

If we fail to protect adequately our intellectual property, our competitive position could be harmed.

Development and protection of our intellectual property are critical to our business. If we do not adequately protect our intellectual property, competitors may be able to practice our technologies. Our success depends in part on our ability to:

When polymers are linked, or conjugated, to drugs, the results are referred to as polymer-drug conjugates. We are developing drug delivery technology that links chemotherapy drugs to biodegradable polymers. For example, XYOTAX is paclitaxel, the active ingredient in Taxol®, one of the world’s best selling cancer drugs, linked to polyglutamate. We may not receive a patent for our polymer-drug conjugates and we may be challenged by the holder of a patent covering the underlying drug.

The patent position of biopharmaceutical firms generally is highly uncertain and involves complex legal and factual questions. The United States Patent and Trademark Office has not established a consistent policy regarding the breadth of claims that it will allow in biotechnology patents. If it allows broad claims, the number and cost of patent interference proceedings in the United States, and the risk of infringement litigation may increase. If it allows narrow claims, the risk of infringement may decrease, but the value of our rights under our patents, licenses and patent applications may also decrease. Patent applications in which we have rights may never issue as patents and the claims of any issued patents may not afford meaningful protection for our technologies or products. We currently have patent properties directed to all approved uses for TRISENOX, however, we have no patent claims covering the composition itself. In addition, patents issued to us or our licensors may be challenged and subsequently narrowed, invalidated or circumvented. Litigation, interference proceedings or other governmental proceedings that we may become involved in with respect to our proprietary technologies or the proprietary technology of others could result in substantial cost to us. Patent litigation is widespread in the biotechnology industry, and any patent litigation could harm our business. Costly litigation might be necessary to protect our orphan drug designations in the United States or EU, which are designations for products meeting criteria based on the size of the potential United States or EU patient population for a drug, respectively, and which entitle that drug to seven years of exclusive rights in the United States market or ten years in the EU market, as applicable, or to protect a patent position or to determine the scope and validity of third party proprietary rights, and we may not have the required resources to pursue any such litigation or to protect our patent rights. Any adverse outcome in litigation with respect to the infringement or validity of any patents owned by third parties could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease using a product or technology.

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We also rely upon trade secrets, proprietary know-how and continuing technological innovation to remain competitive. Third parties may independently develop such know-how or otherwise obtain access to our technology. While we require our employees, consultants and corporate partners with access to proprietary information to enter into confidentiality agreements, these agreements may not be honored.

Our products could infringe on the intellectual property rights of others, which may cause us to engage in costly litigation and, if we are not successful, could cause us to pay substantial damages and prohibit us from selling our products.

We attempt to monitor the patent filings but have not conducted an exhaustive search for patents that may be relevant to our products and product candidates in an effort to guide the design and development of our products to avoid infringement. We may not be able to successfully challenge the validity of these patents and could have to pay substantial damages, possibly including treble damages, for past infringement and attorney’s fees if it is ultimately determined that our products infringe a third party’s patents. Further, we may be prohibited from selling our products before we obtain a license, which, if available at all, may require us to pay substantial royalties. Moreover, third parties may challenge the patents that have been issued or licensed to us. Even if infringement claims against us are without merit, or if we challenge the validity of issued patents, lawsuits take significant time, may be expensive and may divert management attention from other business concerns.

If we are unable to enter into new licensing arrangements, our future product portfolio and potential profitability could be harmed.

One component of our business strategy is in-licensing drug compounds developed by other pharmaceutical and biotechnology companies or academic research laboratories. Substantially all of our product candidates in clinical development are in-licensed from a third party, including TRISENOX, XYOTAX and pixantrone. Competition for new promising compounds and commercial products can be intense. If we are not able to identify future in-licensing opportunities and enter into future licensing arrangements on acceptable terms, our future product portfolio and potential profitability could be harmed.

We may be unable to obtain the raw materials necessary to produce our XYOTAX product candidate in sufficient quantity to meet demand when and if such product is approved.

We may not be able to continue to purchase the materials necessary to produce XYOTAX, including paclitaxel, in adequate volume and quality. Paclitaxel is derived from certain varieties of yew trees. Supply of paclitaxel is controlled by a limited number of companies. We purchase the majority of the paclitaxel we need from a single vendor and this vendor is behind in its delivery schedule of paclitaxel to us. As a result, we may need to obtain paclitaxel from another vendor, which we may not be able to obtain on a timely basis or under acceptable terms. We also purchase the raw material polyglutamic acid from a single source on a purchase order basis. Should the polyglutamic acid purchased from our sources prove to be insufficient in quantity or quality, should a supplier fail to deliver in a timely fashion or at all, or should these relationships terminate, we may not be able to obtain a sufficient supply from alternate sources on acceptable terms, or at all.

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Our dependence on third party manufacturers means that we do not always have sufficient control over the manufacture of our products.

We do not currently have internal facilities for the current Good Manufacturing Practice, or cGMP, manufacture of any of our development or commercial products. In addition, TRISENOX, our first commercial product, is currently manufactured by a single vendor. In 2002, we began the process of qualifying an additional supplier for our finished product manufacturing for TRISENOX. This additional supplier received FDA approval to manufacture TRISENOX in June 2003. Because we do not directly control our suppliers, these vendors may not be able to provide us with finished product when we need it. Plans are in place to develop additional manufacturing resources, such as entering into collaborative arrangements with other parties that have established manufacturing capabilities or elect to have other additional third parties manufacture our products on a contract basis.

We will be dependent upon these third parties to supply us in a timely manner with products manufactured in compliance with cGMPs or similar manufacturing standards imposed by foreign regulatory authorities where our products will be tested and/or marketed. While the FDA and other regulatory authorities maintain oversight for cGMP compliance of drug manufacturers, contract manufacturers may at times violate cGMPs. The FDA and other regulatory authorities may take action against a contract manufacturer who violates cGMPs. Our current manufacturer for TRISENOX has recently been inspected by the FDA and an audit of its facilities by the FDA is ongoing. As a result, the FDA could, among other things, shut down the operations of the manufacturer or disallow the manufacturer to ship product it currently holds. Either outcome could materially affect our operations.

Another one of our products under development, XYOTAX, has a complex manufacturing process, which may prevent us from obtaining a sufficient supply of drug product for the clinical trials and commercial activities currently planned or underway on a timely basis, if at all.

We are subject to extensive government regulation, including the requirement of approval before our products may be marketed.

Regulatory agencies have approved only one of our products, TRISENOX, for sale in the United States and the EU, to treat patients with a type of blood cancer called APL who have relapsed or failed standard therapies. Before we can market TRISENOX for other indications in the United States or EU, we must obtain additional FDA approval and/or approval of the EMEA. Our other products are in development, and will have to be approved by the FDA before they can be marketed in the United States and by the EMEA before they can be marketed in the EU. Obtaining FDA or other national regulatory approval requires substantial time, effort and financial resources, and we may not obtain approval on a timely basis, if at all. If the FDA or the EMEA do not approve our developmental products and any additional indications for marketed products in a timely fashion, or does not approve them at all, or withdraws the approval or otherwise restricts the marketing of our sole approved product, TRISENOX, our business and financial condition may be adversely affected.

In addition, we and our currently marketed product and our product candidates are subject to comprehensive regulation by the FDA and the EMEA. Regulation by the FDA and EMEA begins before approval for marketing is granted and continues during the life of each product. For example, TRISENOX was approved for its current indication by the FDA following fast track review process and by the EMEA “under exceptional circumstances,” and we committed to completing several post-approval requirements to both the FDA and the EMEA, including the conduct of additional clinical studies. If we fail to fulfill these obligations, the FDA or EMEA may withdraw approval of TRISENOX. In addition, the FDA and other regulatory authorities regulate, for example, research and development, including pre-clinical and clinical testing, safety, effectiveness, manufacturing, labeling, advertising, promotion, export, and marketing of our products. Manufacturing processes must conform to cGMPs. The FDA and other regulatory authorities periodically inspect manufacturing facilities to assess compliance with cGMPs. Accordingly, manufacturers must continue to expend time, money, and effort to maintain compliance.

We believe that TRISENOX is prescribed by physicians largely for uses not approved by the FDA. Although physicians may lawfully prescribe pharmaceutical products, such as TRISENOX, for such off-label uses, promotion by us of such off-label uses would be unlawful. Some of our practices intended to make physicians aware of off-label

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uses of TRISENOX, without engaging in off-label promotion, could nevertheless be construed as off-label promotion and it is likely that some instances of off-label promotion occurred in the past. Although we have policies and procedures in place designed to assure ongoing compliance with FDA requirements regarding off-label promotion, some non-compliant actions may nevertheless occur. Regulatory authorities could take enforcement action against us if they believe that we are promoting, or have promoted, TRISENOX for off-label use. Failure to comply with regulatory requirements, including off-label promotion of TRISENOX or other products approved for marketing, could result in various adverse consequences, including possible delay in approval or refusal to approve a product, recalls, seizures, withdrawal of an approved product from the market, and/or the imposition of civil or criminal sanctions.

Additionally, we are subject to numerous regulations and statutes regulating the manner of selling and obtaining reimbursement for our products that receive marketing approval. For example, federal statutes generally prohibit providing certain discounts and payments to physicians to encourage them to prescribe our product. Violations of such regulations or statutes may result in treble damages, criminal or civil penalties, fines or exclusion of CTI or its employees from participation in federal and state health care programs. Although we have policies prohibiting violations of relevant regulations and statutes, unauthorized actions of our employees or consultants (including unlawful off-label promotion), or unfavorable interpretations of such regulations or statutes may result in third parties or regulatory agencies bringing legal proceedings or enforcement actions against us.

As a result of our merger with Novuspharma, we are required to comply with the regulatory structure of Italy, which could result in administrative challenges.

As a result of our merger with Novuspharma, our operations now need to comply not only with applicable laws of and rules of the United States, including Washington law and the rules and regulations of the Securities and Exchange Commission and the Nasdaq National Market, but also the EU legal system and the Republic of Italy, including the rules and regulations of CONSOB and Borsa Italiana, which collectively regulate companies listed on Italy’s public markets such as the Nuovo Mercato. Conducting our operations in a manner that complies with all applicable laws and rules will require us to devote additional time and resources to regulatory compliance matters. For example, the process of seeking to understand and comply with the laws of each country, including tax, labor and regulatory laws, might require us to incur the expense of engaging additional outside counsel, accountants and other professional advisors and might result in delayed business initiatives as we seek to ensure that each new initiative will comply with all regulatory regimes.

As a result of our merger with Novuspharma, we are subject to new legal duties and additional political and economic risks related to our operations in Italy.

As a result of our merger with Novuspharma, a portion of our business is based in Italy. We are subject to duties and risks arising from doing business in Italy, such as:

These risks related to doing business in Italy could harm the results of our operations.

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Uncertainty regarding third party reimbursement and health care cost containment initiatives may limit our returns.

The ongoing efforts of governmental and third party payors to contain or reduce the cost of health care may affect our ability to commercialize our products successfully. Governmental and other third party payors are increasingly attempting to contain health care costs by:

The trend toward managed health care in the United States, the growth of organizations such as health maintenance organizations, and legislative proposals to reform healthcare and government insurance programs could significantly influence the purchase of healthcare services and products, resulting in lower prices and reducing demand for our products. In addition, in almost all European markets, pricing and choice of prescription pharmaceuticals are subject to governmental control. Therefore, the price of our products and their reimbursement in Europe will be determined by national regulatory authorities.

Even if we succeed in bringing any of our proposed products to the market, they may not be considered cost-effective and third party reimbursement might not be available or sufficient. If adequate third party coverage is not available, we may not be able to maintain price levels sufficient to realize an appropriate return on our investment in research and product development. In addition, legislation and regulations affecting the pricing of pharmaceuticals may change in ways adverse to us before or after any of our proposed products are approved for marketing. The Medicare Prescription Drug Improvement, and Modernization Act (MMA), enacted last December, will affect reimbursement and purchases of prescription drugs, including cancer drugs. Implementation of the MMA and yet to be issued regulation could have an adverse impact on sales of prescription drugs. While we cannot predict whether any other legislative or regulatory proposals will be adopted, the adoption of other proposals could make it difficult or impossible to sell our products. TRISENOX has been reimbursed by third party payors, but there is no guarantee this reimbursement will continue.

We face direct and intense competition from our competitors in the biotechnology and pharmaceutical industries and we may not compete successfully against them.

Competition in the oncology industry is intense and is accentuated by the rapid pace of technological development. We anticipate that we will face increased competition in the future as new companies enter our markets. Our competitors in the United States and elsewhere are numerous and include, among others, major multinational pharmaceutical companies, specialized biotechnology companies and universities and other research institutions. Specifically:

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Many of our competitors, either alone or together with their collaborators and in particular, the multinational pharmaceutical companies, have substantially greater financial resources and development and marketing teams than us. In addition, many of our competitors, either alone or together with their collaborators, have significantly greater experience than we do in developing, manufacturing and marketing products. As a result, these companies’ products might come to market sooner or might prove to be more effective, to be less expensive, to have fewer side effects or to be easier to administer than ours. In any such case, sales of our products or eventual products would likely suffer and we might never recoup the significant investments we are making to develop these product candidates.

If we lose our key personnel or we are unable to attract and retain additional personnel, we may be unable to pursue collaborations or develop our own products.

We are highly dependent on Dr. James A. Bianco, our president and chief executive officer, Dr. Jack W. Singer, our chief medical officer and Silvano Spinelli, our executive vice president of development and managing director of European operations. The loss of any one of these principal members of our scientific or management staff, or failure to attract or retain other key scientific employees, could prevent us from pursuing collaborations or developing and commercializing our products and core technologies. Recruiting and retaining qualified scientific personnel to perform research and development work are critical to our success. There is intense competition for qualified scientists and managerial personnel from numerous pharmaceutical and biotechnology companies, as well as from academic and government organizations, research institutions and other entities. In addition, we will rely on consultants and advisors, including scientific and clinical advisors, to assist us in formulating our research and development strategy. All of our consultants and advisors will be employed by other employers or are self-employed, and will have commitments to or consulting or advisory contracts with other entities that may limit their availability to us.

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The integration of Novuspharma’s business and operations will be a challenging, complex, time-consuming and expensive process and may disrupt our business if not completed in a timely and efficient manner.

The challenges involved in the integration of Novuspharma include the following: