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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended June 30, 2006

OR



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

For the transition period from  to

Commission file number: 0-19825



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SCICLONE PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-3116852                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. employer Identification no.)
|                                                               | 
|901 Mariners Island Blvd., Suite 205, San Mateo, California   |  | 94404                               
|(Address of principal executive offices)                       |  | (Zip code)                          

(650) 358-3456

(Registrants telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)



---

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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (Check one).



|                         |  |                      |  |                       
|------------------------ |  | -------------------- |  | ----------------------
|Large accelerated filer ̈ |  | Accelerated filer  x |  | Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).    Yes ̈No  x

As of June 30, 2006, 45,899,874 shares of the registrants Common Stock, $0.001 par value, were issued and outstanding.



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##### Table of Contents

SCICLONE PHARMACEUTICALS, INC.

INDEX



|           |  |                                                                                                                        |  |         
|---------- |  | ---------------------------------------------------------------------------------------------------------------------- |  | --------
|           |  |                                                                                                                        |  | PAGE NO.
|PART I.    |  | FINANCIAL INFORMATION                                                                                                  |  |         
|           |  |                                                                                                                       
|Item 1.    |  | Condensed Consolidated Financial Statements (Unaudited)                                                                |  |         
|           |  |                                                                                                                       
|           |  | Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005                                        |  | 3       
|           |  |                                                                                                                       
|           |  | Condensed Consolidated Statements of Operations for the Three-month and Six-month periods ended June 30, 2006 and 2005 |  | 4       
|           |  |                                                                                                                       
|           |  | Condensed Consolidated Statements of Cash Flows for the Six-month periods ended June 30, 2006 and 2005                 |  | 5       
|           |  |                                                                                                                       
|           |  | Notes to Condensed Consolidated Financial Statements                                                                   |  | 6       
|           |  |                                                                                                                       
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                  |  | 16      
|           |  |                                                                                                                       
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                                             |  | 31      
|           |  |                                                                                                                       
|Item 4.    |  | Controls and Procedures                                                                                                |  | 31      
|           |  |                                                                                                                       
|PART II.   |  | OTHER INFORMATION                                                                                                      |  |         
|           |  |                                                                                                                       
|Item 1.    |  | Legal Proceedings                                                                                                      |  | 32      
|           |  |                                                                                                                       
|Item 1A.   |  | Risk Factors                                                                                                           |  | 32      
|           |  |                                                                                                                       
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                                    |  | 35      
|           |  |                                                                                                                       
|Item 6.    |  | Exhibits                                                                                                               |  | 36      
|           | 
|Signatures |  | 38                                                                                                                    



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##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

SCICLONE PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                     |  |               |              |   |                   |   |              |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------------ | - | ----------------- | - | ------------ | -
|                                                                                                                                                     |  | June 30, 2006 |              |   | December 31, 2005 |  
|                                                                                                                                                     |  | (unaudited)   |              |   |                   |  
|ASSETS                                                                                                                                               |  |               |              |   |                   |   |              |  
|Current assets:                                                                                                                                      |  |               |              |   |                   |   |              |  
|Cash and cash equivalents                                                                                                                            |  | $             | 27,500,000   |   |                   | $ | 25,845,000   |  
|Restricted short-term investments                                                                                                                    |  |               | 696,000      |   |                   |   | 692,000      |  
|Other short-term investments                                                                                                                         |  |               | 15,895,000   |   |                   |   | 15,719,000   |  
|Accounts receivable, net of allowance of $49,000 in 2006 and $82,000 in 2005.                                                                        |  |               | 10,480,000   |   |                   |   | 9,701,000    |  
|Inventories                                                                                                                                          |  |               | 3,227,000    |   |                   |   | 3,272,000    |  
|Prepaid expenses and other current assets                                                                                                            |  |               | 1,624,000    |   |                   |   | 1,890,000    |  
|                                                                                                                                                     |  |               |              |   |                   |   |              |  
|Total current assets                                                                                                                                 |  |               | 59,422,000   |   |                   |   | 57,119,000   |  
|Property and equipment, net                                                                                                                          |  |               | 328,000      |   |                   |   | 380,000      |  
|Intangible assets, net                                                                                                                               |  |               | 437,000      |   |                   |   | 472,000      |  
|Other assets                                                                                                                                         |  |               | 1,554,000    |   |                   |   | 1,544,000    |  
|                                                                                                                                                     |  |               |              |   |                   |   |              |  
|Total assets                                                                                                                                         |  | $             | 61,741,000   |   |                   | $ | 59,515,000   |  
|                                                                                                                                                     |  |               |              |   |                   |   |              |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                 |  |               |              |   |                   |   |              |  
|Current liabilities:                                                                                                                                 |  |               |              |   |                   |   |              |  
|Accounts payable                                                                                                                                     |  | $             | 511,000      |   |                   | $ | 626,000      |  
|Accrued compensation and employee benefits                                                                                                           |  |               | 1,131,000    |   |                   |   | 1,960,000    |  
|Accrued professional fees                                                                                                                            |  |               | 943,000      |   |                   |   | 642,000      |  
|Other accrued expenses                                                                                                                               |  |               | 1,589,000    |   |                   |   | 1,687,000    |  
|Accrued clinical trial expenses                                                                                                                      |  |               | 1,547,000    |   |                   |   | 1,658,000    |  
|Deferred revenue                                                                                                                                     |  |               | 61,000       |   |                   |   | 211,000      |  
|Convertible notes payable                                                                                                                            |  |               |             |   |                   |   | 1,600,000    |  
|                                                                                                                                                     |  |               |              |   |                   |   |              |  
|Total current liabilities                                                                                                                            |  |               | 5,782,000    |   |                   |   | 8,384,000    |  
|Other long-term liabilities                                                                                                                          |  |               | 10,000       |   |                   |   | 68,000       |  
|Commitments and contingencies                                                                                                                        |  |               |              |   |                   |   |              |  
|Stockholders equity:                                                                                                                                |  |               |              |   |                   |   |              |  
|Preferred stock; $0.001 par value; 10,000,000 shares authorized; no shares outstanding                                                               |  |               |             |   |                   |   |             |  
|Common stock; $0.001 par value; 75,000,000 shares authorized; 45,899,874 and 45,877,420 shares issued and outstanding in 2006 and 2005,
respectively |  |               | 46,000       |   |                   |   | 46,000       |  
|Additional paid-in capital.                                                                                                                          |  |               | 211,577,000  |   |                   |   | 210,245,000  |  
|Accumulated other comprehensive income                                                                                                               |  |               | 71,000       |   |                   |   | 53,000       |  
|Accumulated deficit                                                                                                                                  |  |               | (155,745,000 | ) |                   |   | (159,281,000 | )
|                                                                                                                                                     |  |               |              |   |                   |   |              |  
|Total stockholders equity                                                                                                                           |  |               | 55,949,000   |   |                   |   | 51,063,000   |  
|                                                                                                                                                     |  |               |              |   |                   |   |              |  
|Total liabilities and stockholders equity                                                                                                           |  | $             | 61,741,000   |   |                   | $ | 59,515,000   |  
|                                                                                                                                                     |  |               |              |   |                   |   |              |  

See notes to condensed consolidated financial statements



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SCICLONE PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)



|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|------------------------------------------ |  | --------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                           |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |  
|                                           |  | 2006                        |            |   | 2005                      |   |            | 2006 |  |   | 2005       |  
|Product sales                              |  | $                           | 7,910,000  |   |                           | $ | 6,851,000  |      |  | $ | 15,699,000 |   |  | $ | 13,512,000 |  
|Contract revenue                           |  |                             | 54,000     |   |                           |   | 134,000    |      |  |   | 144,000    |   |  |   | 268,000    |  
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total revenues                             |  |                             | 7,964,000  |   |                           |   | 6,985,000  |      |  |   | 15,843,000 |   |  |   | 13,780,000 |  
|                                           |  |                             |            |  
|Cost of product sales                      |  |                             | 1,373,000  |   |                           |   | 1,166,000  |      |  |   | 2,939,000  |   |  |   | 2,163,000  |  
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Gross margin                               |  |                             | 6,591,000  |   |                           |   | 5,819,000  |      |  |   | 12,904,000 |   |  |   | 11,617,000 |  
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Operating expenses:                        |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Research and development                   |  |                             | 3,901,000  |   |                           |   | 3,479,000  |      |  |   | 7,730,000  |   |  |   | 6,960,000  |  
|Sales and marketing                        |  |                             | 2,843,000  |   |                           |   | 2,432,000  |      |  |   | 5,675,000  |   |  |   | 4,760,000  |  
|General and administrative                 |  |                             | 2,294,000  |   |                           |   | 1,588,000  |      |  |   | 4,681,000  |   |  |   | 3,208,000  |  
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total operating expenses                   |  |                             | 9,038,000  |   |                           |   | 7,499,000  |      |  |   | 18,086,000 |   |  |   | 14,928,000 |  
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Loss from operations                       |  |                             | (2,447,000 | ) |                           |   | (1,680,000 | )    |  |   | (5,182,000 | ) |  |   | (3,311,000 | )
|Interest and investment income             |  |                             | 446,000    |   |                           |   | 286,000    |      |  |   | 798,000    |   |  |   | 519,000    |  
|Interest and investment expense            |  |                             | (22,000    | ) |                           |   | (91,000    | )    |  |   | (63,000    | ) |  |   | (181,000   | )
|Other income (expense), net(1)             |  |                             | 7,983,000  |   |                           |   | (20,000    | )    |  |   | 7,983,000  |   |  |   | (26,000    | )
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income (loss)                          |  | $                           | 5,960,000  |   |                           | $ | (1,505,000 | )    |  | $ | 3,536,000  |   |  | $ | (2,999,000 | )
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Earnings (loss) per share:                 |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Basic net income (loss) per share          |  | $                           | 0.13       |   |                           | $ | (0.03      | )    |  | $ | 0.08       |   |  | $ | (0.07      | )
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Diluted net income (loss) per share        |  | $                           | 0.13       |   |                           | $ | (0.03      | )    |  | $ | 0.08       |   |  | $ | (0.07      | )
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted average shares used in computing: |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Basic net income (loss) per share          |  |                             | 45,899,646 |   |                           |   | 45,002,383 |      |  |   | 45,895,784 |   |  |   | 44,851,916 |  
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Diluted net income (loss) per share        |  |                             | 46,090,981 |   |                           |   | 45,002,383 |      |  |   | 46,076,921 |   |  |   | 44,851,916 |  
|                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  

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|(1) | For the three-month and six-month periods ended June 30, 2006, other income included $8,000,000 from the settlement of a clinical trial dispute.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------

See notes to condensed consolidated financial statements



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SCICLONE PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)



|                                                                                     |  |                           |            |   |      |   |            |  
|------------------------------------------------------------------------------------ |  | ------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                     |  | Six Months Ended June 30, |           
|                                                                                     |  | 2006                      |            |   | 2005 |  
|Operating activities:                                                                |  |                           |            |   |      |   |            |  
|Net income (loss)                                                                    |  | $                         | 3,536,000  |   |      | $ | (2,999,000 | )
|Adjustments to reconcile net income (loss) to net cash used in operating activities: |  |                           |            |   |      |   |            |  
|Depreciation and amortization                                                        |  |                           | 118,000    |   |      |   | 111,000    |  
|Loss from disposal of property and equipment                                         |  |                           | 1,000      |   |      |   | 1,000      |  
|Non cash expense related to employee stock options                                   |  |                           | 1,231,000  |   |      |   | 49,000     |  
|Changes in operating assets and liabilities:                                         |  |                           |            |   |      |   |            |  
|Accounts receivable                                                                  |  |                           | (779,000   | ) |      |   | 1,075,000  |  
|Inventories                                                                          |  |                           | 101,000    |   |      |   | 629,000    |  
|Prepaid expenses and other assets                                                    |  |                           | 249,000    |   |      |   | 332,000    |  
|Accounts payable and other accrued expenses                                          |  |                           | (212,000   | ) |      |   | (742,000   | )
|Accrued compensation and employee benefits                                           |  |                           | (829,000   | ) |      |   | (633,000   | )
|Accrued clinical trials expenses                                                     |  |                           | (111,000   | ) |      |   | (30,000    | )
|Accrued professional fees                                                            |  |                           | 301,000    |   |      |   | 91,000     |  
|Long-term liabilities                                                                |  |                           | (58,000    | ) |      |   | (544,000   | )
|Deferred revenue                                                                     |  |                           | (150,000   | ) |      |   | (268,000   | )
|                                                                                     |  |                           |            |   |      |   |            |  
|Net cash provided by (used in) operating activities                                  |  |                           | 3,398,000  |   |      |   | (2,928,000 | )
|                                                                                     |  |                           |            |   |      |   |            |  
|Investing activities:                                                                |  |                           |            |   |      |   |            |  
|Purchases of property and equipment                                                  |  |                           | (26,000    | ) |      |   | (42,000    | )
|Purchases of short-term investments                                                  |  |                           | (161,000   | ) |      |   | (52,000    | )
|                                                                                     |  |                           |            |   |      |   |            |  
|Net cash used in investing activities                                                |  |                           | (187,000   | ) |      |   | (94,000    | )
|                                                                                     |  |                           |            |   |      |   |            |  
|Financing activities:                                                                |  |                           |            |   |      |   |            |  
|Proceeds from issuances of common stock, net of financing costs                      |  |                           | 44,000     |   |      |   | 1,083,000  |  
|Repayment of notes payable                                                           |  |                           | (1,600,000 | ) |      |   |           |  
|                                                                                     |  |                           |            |   |      |   |            |  
|Net cash (used in) provided by financing activities                                  |  |                           | (1,556,000 | ) |      |   | 1,083,000  |  
|                                                                                     |  |                           |            |   |      |   |            |  
|Net increase (decrease) in cash and cash equivalents                                 |  |                           | 1,655,000  |   |      |   | (1,939,000 | )
|Cash and cash equivalents, beginning of period                                       |  |                           | 25,845,000 |   |      |   | 41,204,000 |  
|                                                                                     |  |                           |            |   |      |   |            |  
|Cash and cash equivalents, end of period                                             |  | $                         | 27,500,000 |   |      | $ | 39,265,000 |  
|                                                                                     |  |                           |            |   |      |   |            |  

See notes to condensed consolidated financial statements



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SCICLONE PHARMACEUTICALS, INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)



|1. | Basis of Presentation
|-- | ---------------------

SciClone was
reincorporated in the State of Delaware on July 18, 2003. The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States consistent with
those applied in, and should be read in conjunction with, the audited financial statements for the year ended December 31, 2005 included in the Companys Form 10-K as filed with the Securities and Exchange Commission. The interim financial
information reflects all adjustments, consisting only of normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented and are not necessarily indicative of
results for subsequent interim periods or for the full year. The condensed consolidated balance sheet data at December 31, 2005 is 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. The Company has made a classification change between short-term and long-term liabilities in the consolidated balance sheet as of December 31,
2005 to conform to the current period presentation. As of December 31, 2005, $68,000 was reclassified from accrued compensation and employee benefits to other long-term liabilities.



|2. | Significant Accounting Policies
|-- | -------------------------------

Revenue
Recognition

The Company recognizes revenue from product sales at the time of shipment. There are no significant customer acceptance
requirements or post shipment obligations on the part of the Company. Sales to importing agents or distributors are recognized at time of shipment when title to the product is transferred to them, and they do not have contractual rights of return
except under limited terms regarding product quality. However, the Company will replace products that have expired or are deemed to be damaged or defective when delivered. Payments by the importing agents and distributors are not contingent upon
sale to the end user by the importing agents or distributors.

Contract revenue for research and development is recorded as earned based on
the performance requirements of the contract. Nonrefundable contract fees for which no further performance obligations exist, and there is no continuing involvement by the Company, are recognized on the earlier of when the payments are received or
when collection is assured.

Revenue associated with substantive performance milestones is recognized based on the achievement of the
milestones, as defined in the respective agreements and provided that (i) the milestone event is substantive and its achievement is not reasonably assured at the inception of the agreement, and (ii) there are no future performance
obligations associated with the milestone payment.



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Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding for the period.
Diluted net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common equivalent shares outstanding for the period. Diluted net income per share includes any dilutive impact from stock options
outstanding using the treasury stock method.

The following is a reconciliation of the numerator and denominators of the basic and diluted
EPS computations:



|                                                                                           |  |                             |            |      |                           |            |      |  |      |            |  |   |            |  
|------------------------------------------------------------------------------------------ |  | --------------------------- | ---------- | ---- | ------------------------- | ---------- | ---- |  | ---- | ---------- |  | - | ---------- | -
|                                                                                           |  | Three months ended June 30, |            |      | Six months ended June 30, |           
|                                                                                           |  | 2006                        |            | 2005 |                           |            | 2006 |  | 2005 |           
|Numerator:                                                                                 |  |                             |            |      |                           |            |      |  |      |            |  |   |            |  
|Net income (loss)                                                                          |  | $                           | 5,960,000  |      | $                         | (1,505,000 | )    |  | $    | 3,536,000  |  | $ | (2,999,000 | )
|                                                                                           |  |                             |            |      |                           |            |      |  |      |            |  |   |            |  
|Denominator:                                                                               |  |                             |            |      |                           |            |      |  |      |            |  |   |            |  
|Weighted-average shares outstanding used to compute basic EPS                              |  |                             | 45,899,646 |      |                           | 45,002,383 |      |  |      | 45,895,784 |  |   | 44,851,916 |  
|Effect of dilutive stock options                                                           |  |                             | 191,335    |      |                           |           |      |  |      | 181,137    |  |   |           |  
|                                                                                           |  |                             |            |      |                           |            |      |  |      |            |  |   |            |  
|Weighted-average shares outstanding and dilutive stock options used to compute diluted EPS |  |                             | 46,090,981 |      |                           | 45,002,383 |      |  |      | 46,076,921 |  |   | 44,851,916 |  
|                                                                                           |  |                             |            |      |                           |            |      |  |      |            |  |   |            |  

For the three-month and six-month periods ended June 30, 2006, approximately 6,820,000 shares
and 6,568,000 shares, respectively, attributable to outstanding stock options were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.

Stock-Based Compensation

Effective
January 1, 2006, the Company adopted the fair value recognition provisions of Financial Accounting Standards Board (FASB) Statement No. 123(R), Share-Based Payment, (FAS 123R). Prior to January 1, 2006, the
Company accounted for share-based payments under the recognition and measurement provisions of Accounting Principles Board Opinion 25 (APB 25) and related Interpretations, as permitted by FASB Statement No. 123, Accounting for
Stock-Based Compensation (FAS 123). Accordingly, the Company did not recognize compensation expense in accounting for its employee stock purchase plan or its stock option plans for options to employees and directors granted with exercise
prices at fair market value.

The Company adopted FAS 123R using the modified-prospective transition method as of January 1, 2006.
Under this method, compensation cost recognized in the six-month period ended June 30, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair
value estimated in accordance with the provisions of FAS 123. Compensation cost also includes all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of FAS
123R. Compensation cost is calculated on the date of grant using the fair value of the option as determined using the Black Scholes method and the single option approach. The Company amortizes the compensation cost over the vesting period, which is
generally four years, using the straight line attribution method. Results for prior periods have not been restated to reflect the impact of FAS 123R.

Stock-based compensation expense recognized in the Consolidated Statement of Operations for the three months and six months ended June 30, 2006 is based on awards ultimately expected to vest. FAS 123R requires
forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures. We record stock-based
compensation costs only for those awards that are expected to vest. In the Companys pro forma information required under FAS 123 for periods prior to January 1, 2006, the Company accounted for forfeitures as they occurred.



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We have not recognized, and do not expect to recognize in the near future, any tax benefit related to
employee stock-based compensation cost as a result of the full valuation allowance on our net deferred tax assets including our net operating loss carryforwards.

The following table illustrates the effect on income (loss) and net income (loss) per share, had compensation expense for the Companys stock option and employee stock purchase plans been determined based on the
fair value at the grant date consistent with the provisions of FAS 123:



|                                                                                                            |  |                                 |            |   |                               |   |            |  
|----------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ----------------------------- | - | ---------- | -
|                                                                                                            |  | Three MonthsEnded June 30, 2005 |            |   | Six MonthsEnded June 30, 2005 |  
|Net loss - as reported                                                                                      |  | $                               | (1,505,000 | ) |                               | $ | (2,999,000 | )
|Total stock-based employee compensation expense determined under the fair value based method for all awards |  |                                 | (807,000   | ) |                               |   | (1,494,000 | )
|                                                                                                            |  |                                 |            |   |                               |   |            |  
|Net loss - pro forma                                                                                        |  | $                               | (2,312,000 | ) |                               | $ | (4,493,000 | )
|                                                                                                            |  |                                 |            |   |                               |   |            |  
|Basic and diluted net loss per share - as reported                                                          |  | $                               | (0.03      | ) |                               | $ | (0.07      | )
|                                                                                                            |  |                                 |            |   |                               |   |            |  
|Basic and diluted net loss per share - pro forma                                                            |  | $                               | (0.05      | ) |                               | $ | (0.10      | )
|                                                                                                            |  |                                 |            |   |                               |   |            |  



|3. | Stockholders Equity
|-- | -------------------

Stock Award Plans

In August 1991, the Board of Directors and stockholders of the Company approved the 1991 Stock Plan (the 1991 Plan) and
reserved 1,300,000 shares for issuance thereunder. In May 1993, the Board of Directors and stockholders of the Company approved a 2,150,000 increase in the shares reserved under the 1991 Plan. The 1991 Plan permits the award of incentive or
nonqualified stock options and shares of common stock under restricted stock purchase agreements.

In January 1992, the Board of Directors
and stockholders of the Company approved the 1992 Stock Plan (the 1992 Plan) and reserved 240,000 shares for issuance thereunder. The 1992 Plan permits the award of incentive or nonqualified stock options which must be exercised in cash.

In June 1995, the Board of Directors and the stockholders of the Company approved the 1995 Equity Incentive Plan (the 1995
Plan) and reserved 1,250,000 shares for issuance thereunder. The 1995 Plan permits the award of incentive or nonqualified stock options and shares of common stock under restricted stock awards. In May 1997, the Board of Directors and
stockholders of the Company approved a 750,000 increase in the shares reserved under the 1995 Plan. In June 1998, June 2000 and June 2002 the Board of Directors and stockholders of the Company approved increases of 1,500,000, 1,250,000 and
1,350,000, respectively, in the shares reserved under the 1995 Plan.

In May 2004, the Board of Directors and the stockholders of the
Company approved the 2004 Stock Option Plan (the 2004 Plan) and reserved 2,500,000 shares for issuance thereunder. The 2004 Plan permits the award of incentive stock options or nonstatutory stock options. In June 2005, the Board of
Directors and stockholders of the Company approved an increase in the maximum number of shares issuable under the 2004 Plan by 2,300,000 shares to a total of 4,800,000 shares. The Board of Directors and stockholders also approved amendments to the
2004 Plan to expand the types of stock-based incentives authorized under the 2004 Plan and to restate the 2004 Plan as the 2005 Equity Incentive Plan (the 2005 Plan). The 2005 Plan permits the grant of incentive stock options,
nonstatutory stock options, stock appreciation rights, stock purchase rights, stock bonuses, restricted stock units, performance shares and performance units. The options are granted at fair market value on the date of grant and expire ten years
from the date of grant.

Under the 1991, 1992, 1995 and 2005 Plans, options are exercisable upon conditions determined by the Board of
Directors and expire ten years from the date of grant. Options are generally granted at fair market value on the date of grant and vest over time, generally four years. Although the 1991, 1992 and 1995 Plans have expired, the outstanding options
relating to them are fully valid.

In June 1995, the Board of Directors and the stockholders of the Company approved the 1995 Nonemployee
Director Stock Option Plan (the Nonemployee Director Plan) and reserved 250,000 shares for issuance thereunder. In June



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2000 and June 2002 the Board of Directors and stockholders of the Company approved an increase of 250,000 in the shares reserved for issuance under the
Nonemployee Director Plan. In May 2004, the Board of Directors and stockholders of the Company approved the 2004 Outside Directors Stock Option Plan and reserved 465,000 shares for issuance thereunder and the Nonemployee Director Plan was canceled.
The 2004 Outside Directors Stock Option Plan automatically grants nonqualified stock options to nonemployee directors upon their appointment or first election to the Companys Board of Directors (Initial Grant) and annually upon
their reelection to the Board of Directors at the Companys Annual Meeting of Stockholders (Annual Grant). The options are granted at fair market value on the date of grant and expire ten years from the date of grant. Initial Grants
will become exercisable in three equal annual installments beginning on the first anniversary of the date of grant, and Annual Grants will become exercisable in twelve equal monthly installments from the date of grant, subject in each case to the
Outside Directors continuous service on our Board of Directors. In June 2005, the Board of Directors and stockholders of the Company approved an increase in the maximum number of shares issuable under the 2004 Outside Directors Stock Option
Plan by 550,000 shares to a total of 1,015,000 shares.

In July 1996, the Board of Directors and stockholders of the Company approved the
1996 Employee Stock Purchase Plan (the ESPP) and reserved 500,000 shares for issuance thereunder. In June 2003, the Board of Directors and stockholders of the Company approved an increase of 500,000 in the shares reserved for issuance
under the 1996 Employee Stock Purchase Plan. All full-time employees are eligible to participate in the ESPP. Under the terms of the ESPP, employees can choose to have up to 15% of their salary withheld to purchase the Companys common stock.
The purchase price of the stock is 85% of the lower of the fair market value as of the first and last trading day of each quarterly participation period. Under the ESPP, the Company sold 80,113, 124,798, and 127,920 shares to employees in 2005, 2004
and 2003, respectively. In January 2006, the Board of Directors amended the ESPP to provide that, for each Offering Period commencing after January 31, 2006, the purchase price of the stock shall be equal to 95% of the fair market value of a
share of the Companys Common Stock on the Purchase Date (or such other amount as may be established by the Board).

The following
table summarizes stock option activity during the three-month period ended June 30, 2006 under all option plans:



|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|---------------------------------------------------- |  | --------------- | - |  | --------------------------------------- | ---- | ---------------------------------------- | ---- | ------------------------ | - | -------
|                                                     |  | Number ofShares |   |  | Weighted-AverageExercise PricePer Share |      | Weighted-AverageRemainingContractualTerm |      | AggregateIntrinsic Value
|Options outstanding at March 31, 2006                |  | 7,392,276       |   |  | $                                       | 4.40 |                                          |      |                          |   |        
|Granted                                              |  | 1,180,000       |   |  | $                                       | 2.49 |                                          |      |                          |   |        
|Exercised                                            |  |                |   |  | $                                       | 0    |                                          |      |                          |   |        
|Forfeited                                            |  | (600,000        | ) |  | $                                       | 2.97 |                                          |      |                          |   |        
|Expired                                              |  | (3,500          | ) |  | $                                       | 3.68 |                                          |      |                          |   |        
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|Options outstanding at June 30, 2006                 |  | 7,968,776       |   |  | $                                       | 4.22 |                                          | 6.98 |                          | $ | 276,796
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|Options vested and expected to vest at June 30, 2006 |  | 7,659,542       |   |  | $                                       | 4.28 |                                          | 6.89 |                          |   |        
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|Options exercisable at June 30, 2006                 |  | 4,682,446       |   |  | $                                       | 5.01 |                                          | 5.40 |                          | $ | 276,756
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        



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##### Table of Contents

The following table summarizes stock option activity during the six-month period ended June 30, 2006
under all option plans:



|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|---------------------------------------------------- |  | --------------- | - |  | --------------------------------------- | ---- | ---------------------------------------- | ---- | ------------------------ | - | -------
|                                                     |  | Number ofShares |   |  | Weighted-AverageExercise PricePer Share |      | Weighted-AverageRemainingContractualTerm |      | AggregateIntrinsic Value
|Options outstanding at December 31, 2005             |  | 6,527,126       |   |  | $                                       | 4.69 |                                          |      |                          |   |        
|Granted                                              |  | 2,094,000       |   |  | $                                       | 2.42 |                                          |      |                          |   |        
|Exercised                                            |  |                |   |  | $                                       | 0    |                                          |      |                          |   |        
|Forfeited                                            |  | (619,500        | ) |  | $                                       | 3.01 |                                          |      |                          |   |        
|Expired                                              |  | (32,850         | ) |  | $                                       | 5.08 |                                          |      |                          |   |        
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|Options outstanding at June 30, 2006                 |  | 7,968,776       |   |  | $                                       | 4.22 |                                          | 6.98 |                          | $ | 276,796
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|Options vested and expected to vest at June 30, 2006 |  | 7,659,542       |   |  | $                                       | 4.28 |                                          | 6.89 |                          |   |        
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        
|Options exercisable at June 30, 2006                 |  | 4,682,446       |   |  | $                                       | 5.01 |                                          | 5.40 |                          | $ | 276,756
|                                                     |  |                 |   |  |                                         |      |                                          |      |                          |   |        

The following table summarizes information concerning outstanding and exercisable options as of
June 30, 2006:



|                         |  |                     |  |                                          |  |                               |       |                   |           |                               |   |      
|------------------------ |  | ------------------- |  | ---------------------------------------- |  | ----------------------------- | ----- | ----------------- | --------- | ----------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                     
|Range of Exercise Prices |  | NumberOutstanding   |  | WeightedAverageRemainingContractual Term |  | WeightedAverageExercise Price |       | NumberExercisable |           | WeightedAverageExercise Price
|$1.22 - $2.31            |  | 373,429             |  | 2.93                                     |  | $                             | 1.55  |                   | 363,596   |                               | $ | 1.53 
|$2.34 - $2.34            |  | 905,000             |  | 9.65                                     |  | $                             | 2.34  |                   |          |                               | $ | 0.00 
|$2.38 - $2.47            |  | 368,300             |  | 5.87                                     |  | $                             | 2.44  |                   | 188,300   |                               | $ | 2.41 
|$2.49 - $2.49            |  | 1,000,000           |  | 9.92                                     |  | $                             | 2.49  |                   |          |                               | $ | 0.00 
|$2.67 - $3.40            |  | 1,223,000           |  | 8.62                                     |  | $                             | 3.28  |                   | 647,435   |                               | $ | 3.21 
|$3.68 - $4.08            |  | 799,945             |  | 5.46                                     |  | $                             | 3.72  |                   | 751,070   |                               | $ | 3.72 
|$4.25 - $5.00            |  | 1,250,230           |  | 5.91                                     |  | $                             | 4.69  |                   | 933,830   |                               | $ | 4.61 
|$5.23 - $5.83            |  | 1,233,197           |  | 6.6                                      |  | $                             | 5.64  |                   | 991,280   |                               | $ | 5.62 
|$5.88 - $10.75           |  | 810,675             |  | 3.99                                     |  | $                             | 9.51  |                   | 801,935   |                               | $ | 9.54 
|$12.50 - $12.50          |  | 5,000               |  | 3.67                                     |  | $                             | 12.50 |                   | 5,000     |                               | $ | 12.50
|                         |  |                     |  |                                          |  |                               |       |                   |           |                               |   |      
|                         |  | 7,968,776           |  | 6.98                                     |  | $                             | 4.22  |                   | 4,682,446 |                               | $ | 5.01 
|                         |  |                     |  |                                          |  |                               |       |                   |           |                               |   |      

There were no options exercised for the three-month and six-month periods ended June 30, 2006
and the total intrinsic value of options exercised for the three-month and six-month periods in 2005 was approximately $878,000 and $990,000, respectively.



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The following table illustrates the allocation of compensation cost related to stock options and employee
stock purchases to the income statement line items:



|                           |  |                             |         |                           |   |        |  |      |           |  |   |       
|-------------------------- |  | --------------------------- | ------- | ------------------------- | - | ------ |  | ---- | --------- |  | - | ------
|                           |  | Three Months Ended June 30, |         | Six Months Ended June 30,
|                           |  | 2006                        |         | 2005                      |   | 2006   |  | 2005
|Research and development   |  | $                           | 210,000 |                           | $ |       |  | $    | 444,000   |  | $ |      
|Sales and marketing        |  | $                           | 161,000 |                           | $ |       |  |      | 331,000   |  |   |      
|General and administrative |  | $                           | 186,000 |                           | $ | 49,000 |  |      | 456,000   |  |   | 49,000
|                           |  |                             |         |                           |   |        |  |      |           |  |   |       
|                           |  | $                           | 557,000 |                           | $ | 49,000 |  | $    | 1,231,000 |  | $ | 49,000
|                           |  |                             |         |                           |   |        |  |      |           |  |   |       

As a result of adopting FAS 123R in the three-month and six-month periods ended June 30,
2006, our income from operations and net income for the quarter is approximately $557,000 and $1,231,0000, respectively, lower than if we had continued to account for share-based compensation under APB 25. Basic and diluted income per share for the
three-month and six-month periods ended June 30, 2006 are $0.01 and $0.02 lower, respectively, than if the Company had continued to account for share-based compensation under APB 25. The total compensation cost capitalized in inventory was
approximately $27,000 and $56,000, respectively in the three-month and six-month periods ended June 30, 2006. For both the three-month and six-month periods ended June 30, 2005, there was $49,000 of stock-based compensation cost.

The fair value of employee stock options granted under the Companys stock option plans and the fair value of employee purchase rights
granted under the Companys employee stock purchase plan during the three-month and six-month periods ended June 30, 2006 and 2005 was estimated at the date of grant using the Black-Scholes model with the following assumptions:



|                                                                      |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  
|--------------------------------------------------------------------- |  | --------------------------- | ----- | - | ------------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                      |  | Three Months Ended June 30, |       |   | Six Months Ended June 30, |  
|Stock Option Plan                                                     |  | 2006                        |       |   | 2005                      |   |       | 2006 |  |   | 2005  |  
|Weighted-average fair value of stock options granted                  |  | $                           | 1.46  |   |                           | $ | 2.02  |      |  | $ | 1.37  |   |  | $ | 1.98  |  
|Risk-free interest rate                                               |  |                             | 5.02  | % |                           |   | 3.80  | %    |  |   | 4.73  | % |  |   | 3.60  | %
|Dividend yield                                                        |  |                             | 0.00  | % |                           |   | 0.00  | %    |  |   | 0.00  | % |  |   | 0.00  | %
|Volatility factor of the expected market price of our common stock    |  |                             | 73.79 | % |                           |   | 74.00 | %    |  |   | 73.27 | % |  |   | 75.00 | %
|Weighted-average expected life of option (years)                      |  |                             | 4.09  |   |                           |   | 4.00  |      |  |   | 3.85  |   |  |   | 4.00  |  
|                                                                      |  |                            
|                                                                      |  | Three Months Ended June 30, |       |   | Six Months Ended June 30, |  
|Employee Stock Purchase Plan                                          |  | 2006                        |       |   | 2005                      |   |       | 2006 |  |   | 2005  |  
|Weighted-average fair value of employee stock purchase plan purchases |  | $                           |      |   |                           | $ | 0.40  |      |  | $ | 0.84  |   |  | $ | 0.45  |  
|Risk-free interest rate                                               |  |                             |      |   |                           |   | 3.84  | %    |  |   | 3.17  | % |  |   | 3.82  | %
|Dividend yield                                                        |  |                             |      |   |                           |   | 0.00  | %    |  |   | 0.00  | % |  |   | 0.00  | %
|Volatility factor of the expected market price of our common stock    |  |                             |      |   |                           |   | 74.92 | %    |  |   | 60.59 | % |  |   | 74.65 | %
|Weighted-average expected life (years)                                |  |                             |      |   |                           |   | 0.24  |      |  |   | 0.75  |   |  |   | 0.24  |  

The expected term of options granted is derived from historical data on employee exercises and
terminations. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on the historical volatility of our stock. The expected dividend assumption is based on the
Companys history and expectations of dividend payouts.

In January 2006, the employee stock purchase plan was amended to be a
non-compensatory plan under FAS 123R; therefore, no fair value calculation was performed for purchases subsequent to that date.



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As of June 30, 2006, unamortized compensation expense related to unvested options was approximately
$5,500,000. The weighted average period over which compensation expense related to these options will be recognized is 2.2 years.

The total
fair value of options vested during the three-month and six-month periods ended June 30, 2006 was $657,000 and $1,523,000, respectively.



|4. | Comprehensive Income (Loss)
|-- | ---------------------------

Comprehensive
income (loss) is comprised of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes net unrealized gains and losses on our available-for-sale securities. For the three-month periods ended June 30,
2006 and 2005, the Companys total comprehensive income (loss) amounted $5,975,000 and $(1,497,000), respectively. For the six-month periods ended June 30, 2006 and 2005, the Companys total comprehensive income (loss) amounted
$3,554,000 and $(2,996,000), respectively.



|5. | Marketable Securities
|-- | ---------------------

The following is a
summary of marketable securities at June 30, 2006 and December 31, 2005:



|                                |  |                               |            |                      |   |                     |  |   |           
|------------------------------- |  | ----------------------------- | ---------- | -------------------- | - | ------------------- |  | - | ----------
|                                |  | Available-For Sale Securities
|                                |  | AmortizedCost                 |            | GrossUnrealizedGains |   | EstimatedFair Value
|June 30, 2006:                  |  |                               |            |                      |   |                     |  |   |           
|Certificates of deposit         |  | $                             | 823,000    |                      | $ |                    |  | $ | 823,000   
|Short-term municipal securities |  |                               | 5,450,000  |                      |   |                    |  |   | 5,450,000 
|Corporate equity securities     |  |                               | 51,000     |                      |   | 71,000              |  |   | 122,000   
|                                |  |                               |            |                      |   |                     |  |   |           
|                                |  | $                             | 6,324,000  |                      | $ | 71,000              |  | $ | 6,395,000 
|                                |  |                               |            |                      |   |                     |  |   |           
|December 31, 2005:              |  |                               |            |                      |   |                     |  |   |           
|Certificates of deposit         |  | $                             | 823,000    |                      | $ |                    |  | $ | 823,000   
|Short-term municipal securities |  |                               | 9,450,000  |                      |   |                    |  |   | 9,450,000 
|Corporate equity securities     |  |                               | 51,000     |                      |   | 53,000              |  |   | 104,000   
|                                |  |                               |            |                      |   |                     |  |   |           
|                                |  | $                             | 10,324,000 |                      | $ | 53,000              |  | $ | 10,377,000
|                                |  |                               |            |                      |   |                     |  |   |           
|                                | 
|                                |  | Held-to-Maturity Securities  
|                                |  | AmortizedCost                 |            | GrossUnrealizedGains |   | EstimatedFair Value
|June 30, 2006:                  |  |                               |            |                      |   |                     |  |   |           
|U.S. Treasury securities        |  | $                             | 10,196,000 |                      | $ |                    |  | $ | 10,196,000
|                                |  |                               |            |                      |   |                     |  |   |           
|                                |  | $                             | 10,196,000 |                      | $ |                    |  | $ | 10,196,000
|                                |  |                               |            |                      |   |                     |  |   |           
|December 31, 2005:              |  |                               |            |                      |   |                     |  |   |           
|U.S. Treasury securities        |  | $                             | 6,034,000  |                      | $ |                    |  | $ | 6,034,000 
|                                |  |                               |            |                      |   |                     |  |   |           
|                                |  | $                             | 6,034,000  |                      | $ |                    |  | $ | 6,034,000 
|                                |  |                               |            |                      |   |                     |  |   |           

As of June 30, 2006, there was $696,000 in restricted short-term investments and $15,895,000
in other short-term investments held in available-for-sale securities. As of December 31, 2005, there was $692,000 in restricted short-term investments and $9,685,000 in other short-term investments held in available-for-sale securities. As of
June 30, 2006 and December 31, 2005 all available-for sale securities excluding the short-term municipal securities had maturities of 12 months or less. The short-term municipals are auction rate securities which have long final
maturities; however, because they are highly rated, highly liquid and their interest rate is reset at auction every 30 days, they are included as available-for sale securities. Our interest rate risk associated with the auction rate securities is
limited due to this interest rate reset mechanism.



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##### Table of Contents

As of June 30, 2006 and December 31, 2005, there were $10,196,000 and $6,034,000 respectively
in other short-term investments classified as held-to-maturity securities. These securities are U. S. Treasury bills which will mature in August, November or December 2006. The fair market value of the investments at June 30, 2006 and
December 31, 2005, respectively, approximated their cost.



|6. | Inventories
|-- | -----------

The following is a summary of
inventories at June 30, 2006 and December 31, 2005:



|                 |  |              |           |                  |   |          
|---------------- |  | ------------ | --------- | ---------------- | - | ---------
|                 |  | June 30,2006 |           | December 31,2005
|Raw materials    |  | $            | 780,000   |                  | $ | 797,000  
|Work in progress |  |              | 164,000   |                  |   | 476,000  
|Finished goods   |  |              | 2,283,000 |                  |   | 1,999,000
|                 |  |              |           |                  |   |          
|                 |  | $            | 3,227,000 |                  | $ | 3,272,000
|                 |  |              |           |                  |   |          



|7. | Prepaid Expenses and Other Current Assets
|-- | -----------------------------------------

The following is a summary of prepaid expenses and other current assets at June 30, 2006 and December 31, 2005:



|                                   |  |              |           |                  |   |          
|---------------------------------- |  | ------------ | --------- | ---------------- | - | ---------
|                                   |  | June 30,2006 |           | December 31,2005
|Prepaid insurance                  |  | $            | 233,000   |                  | $ | 702,000  
|Prepaid rent                       |  |              | 107,000   |                  |   | 107,000  
|Prepaid clinical trial expense     |  |              | 34,000    |                  |   | 41,000   
|Prepaid pre-clinical trial expense |  |              | 47,000    |                  |   |         
|VAT receivable                     |  |              | 668,000   |                  |   | 464,000  
|Other prepaid expenses             |  |              | 535,000   |                  |   | 576,000  
|                                   |  |              |           |                  |   |          
|                                   |  | $            | 1,624,000 |                  | $ | 1,890,000
|                                   |  |              |           |                  |   |          



|8. | Intangible Assets
|-- | -----------------

The following is a
summary of intangible assets at June 30, 2006 and December 31, 2005:



|                          |  |               |            |   |                   |   |            |  
|------------------------- |  | ------------- | ---------- | - | ----------------- | - | ---------- | -
|                          |  | June 30, 2006 |            |   | December 31, 2005 |  
|Intangible product rights |  | $             | 2,456,000  |   |                   | $ | 2,456,000  |  
|Accumulated amortization  |  |               | (2,019,000 | ) |                   |   | (1,984,000 | )
|                          |  |               |            |   |                   |   |            |  
|                          |  | $             | 437,000    |   |                   | $ | 472,000    |  
|                          |  |               |            |   |                   |   |            |  

Acquired ZADAXIN product rights are being amortized on a straight-line basis beginning in
September 1998. Amortization expenses for each of the three-month periods ended June 30, 2006 and 2005 was $17,500 and for each of the six-month periods ended June 30, 2006 and 2005 was $35,000. For the years ending December 31, 2006
through 2012, annual amortization expense is expected to be $70,000. Based upon the progress in the ZADAXIN clinical trials and the Companys actual experience of product sales, the Company assessed that the acquired product rights will be
useful to the Company through 2012 when the European patent for the use of ZADAXIN in the treatment of hepatitis C expires. The Companys policy is to identify and record impairment losses on intangible product rights when events and
circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. There have been no impairment losses recorded to date.



|9. | Contract Revenue
|-- | ----------------

In January 2002, the
Company received $2,685,000 from its European partner, Sigma-Tau, under the terms of its collaborative agreement announced in late December 2001. This receipt has been recorded as deferred revenue and is



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##### Table of Contents

being recognized as contract revenue over the course of the ZADAXIN hepatitis C U.S. clinical program and the period of sharing the clinical data from this
program with Sigma-Tau, the substantive performance requirements under the contract.



|10. | Accrued Expenses
|--- | ----------------

The following is a summary
of other accrued expenses at June 30, 2006 and December 31, 2005:



|                                     |  |              |           |                  |   |          
|------------------------------------ |  | ------------ | --------- | ---------------- | - | ---------
|                                     |  | June 30,2006 |           | December 31,2005
|Accrued royalties                    |  | $            | 500,000   |                  | $ | 500,000  
|Accrued pre-clinical trial expenses  |  |              | 65,000    |                  |   | 93,000   
|Accrued interest payable             |  |              |          |                  |   | 32,000   
|Accrued annual reports expense       |  |              | 27,000    |                  |   | 60,000   
|Accrued sales and marketing expenses |  |              | 444,000   |                  |   | 501,000  
|Accrued manufacturing costs          |  |              | 77,000    |                  |   | 47,000   
|Other                                |  |              | 476,000   |                  |   | 454,000  
|                                     |  |              |           |                  |   |          
|                                     |  | $            | 1,589,000 |                  | $ | 1,687,000
|                                     |  |              |           |                  |   |          



|11. | CEO Agreement
|--- | -------------

On June 2, 2006,
Dr. Friedhelm Blobel became our president and CEO and joined our Board of Directors, and Dr. Ira Lawrence resigned as president and CEO and became a consultant to the Company. Dr. Lawrence also continues to serve as a Director of the
Company and will serve as a member of the Business Development Committee and the newly formed Medical Review Committee of the Board of Directors. In accordance with Dr. Lawrences separation agreement, his unvested stock options were
cancelled. His options to purchase 200,000 shares that vested during his time of services as CEO will be exercisable for their term provided that Dr. Lawrence continues his service as a consultant or Director of the Company.

In accordance with the CEO agreement with Dr. Blobel, the Board of Directors is obligated in 2008 to consider an award to Dr. Blobel of a
special cash bonus of up to $300,000, based on his achievement of the previously agreed upon performance targets over the years 2006-2008. The Company will estimate the probable amount of this long-term incentive bonus on a quarterly basis in order
to accrue the bonus over the related performance period. In the quarter ended June 30, 2006, the Company accrued approximately $10,000 relating to the special cash bonus. All expenses related to the agreement with Dr. Blobel will be
recorded to general and administrative expenses.

The employment agreement with Dr. Blobel also includes the award of two options. The
first option is to purchase 400,000 shares of the Companys common stock at an exercise price per share equal to the closing price on the Nasdaq Global Market of a share of the Companys common stock on June 2, 2006. The option has a
term of ten years and will vest in annual installments on each of the first four anniversaries of June 2, 2006. The Company will recognize compensation cost for these options based on the grant-date fair value estimated in accordance with the
provision of FAS 123R. The Company will amortize the compensation cost over the vesting period, which is four years, using the straight line attribution method.

The second option granted to Dr. Blobel is to purchase 600,000 shares of the Companys common stock at an exercise price per share equal to the closing price on the Nasdaq Global Market of a share of the
Companys common stock on June 2, 2006. This option has a term of 10 years and 100,000 shares of such option will vest upon the Companys common stock trading after June 2, 2006 for at least 30 consecutive calendar days at or
greater than a target closing stock price as reported on the Nasdaq Global Market, each of (a) $4.50 on or before June 2, 2009, (b) $6.00 on or before June 2, 2010, (c) $8.00 on or before June 2, 2011, (d) $10.00
on or before June 2, 2012, (e) $12.00 on or before June 2, 2013, and (f) $14.00 on or before June 2, 2014, each price as adjusted for stock dividends, stock splits or similar changes in the Companys capital structure.
The second option is considered an award with a market condition and, therefore, the grant date fair values related to each of the six vesting portions of this award will be calculated and the related compensation cost will be expensed over the
derived service periods for each of the six vesting portions of the award.



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|12. | Other Income
|--- | ------------

On April 3, 2006, we
announced the resolution of our dispute with Schering Plough KK (SPKK) concerning clinical trials conducted in Japan with ZADAXIN. Under the terms of the settlement, SPKK paid SciClone $8,000,000 on April 18, 2006 which has been recorded as
income in the second quarter 2006.



|13. | Income Taxes
|--- | ------------

The Company expects net loss
to approximately break-even for the year ended December 31, 2006. Therefore, the Company did not record any federal or state income tax expense for the three-month and six-month periods ended June 30, 2006.



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

Special Note
Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based on our current expectations, estimates and projections about our
business, industry, managements beliefs and certain assumptions made by us. Words such as anticipate, expect, intend, plan, believe or similar expressions are intended to identify
forward-looking statements including those statements we make regarding our future financial results; anticipated product sales; the sufficiency of our resources to complete clinical trials and other new product development initiatives; the timing
and outcome of clinical trials; the timing of completion of therapy and observation for our clinical trials;ZADAXINs ability to complement existing therapies; prospects for ZADAXIN and our plans for its enhancement and
commercialization; future size of the worldwide hepatitis C virus and other markets; research and development and other expense levels; cash and other asset levels; and the allocation of financial resources to certain trials and programs. These
statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any
forward-looking statements as a result of various factors including, but not limited to, those described under the caption Risk Factors in this Quarterly Report on Form 10-Q. We undertake no obligation to revise or update publicly any
forward-looking statements for any reason.

Overview

SciClone Pharmaceuticals, Inc. is a biopharmaceutical company engaged in the development and commercialization of therapeutics to treat life-threatening diseases, primarily cancer and viral and other infectious
diseases. Our lead product ZADAXIN is currently being evaluated in a large, phase 2 stage IV malignant melanoma clinical trial in Europe. In addition, a large clinical trial is ongoing in Europe using ZADAXIN as part of a novel triple therapy
combination for the treatment of hepatitis C virus (HCV). ZADAXIN is approved for sale internationally, most notably in China where we have an established sales and marketing operation. Part of our strategy in China is to leverage our sales and
marketing capabilities by in-licensing or acquiring the marketing rights to other products to market in this rapidly growing pharmaceutical market.

In December 2005 and June 2006, we reported final results from our two U.S. phase 3 trials evaluating the double therapy combination of ZADAXIN and pegylated interferon alpha to treat HCV patients who had failed previous therapy. The
results from these trials did not demonstrate that ZADAXIN in combination with pegylated interferon alpha provides a statistically significant clinical benefit when compared with pegylated interferon alpha alone. Our European partner, Sigma-Tau, is
conducting a triple therapy combination (ZADAXIN plus pegylated interferon alpha and ribavirin) trial in Europe and we expect that enrollment of this trial will be completed by year-end 2006.

ZADAXIN currently is approved for sale internationally, primarily in Asia, the Middle East and Latin America, for the treatment of hepatitis B virus
(HBV), HCV and for use as a vaccine adjuvant. ZADAXIN is marketed through our wholly-owned subsidiary SciClone Pharmaceuticals International Ltd. (SPIL). In 2005, revenues from the sale of ZADAXIN totaled $27.8 million, of which 91% were to China,
an increasingly important and rapidly growing pharmaceutical market. We have established a strong sales and marketing operation in China with over 100 medical representatives in the field who are dedicated to promoting ZADAXIN to hospital-based
physicians in the major metropolitan areas. While ZADAXIN is approved for the treatment of HBV and as a vaccine adjuvant in China, Chinese physicians are also prescribing it for use in certain cancer and intensive care settings. As part of our
strategy in China, we intend to leverage our capabilities and expand our presence in this market by in-licensing or acquiring the rights to other products to market in China. Accordingly, in June 2006, we achieved a product rights acquisition in our
agreement with Biocompatibles International plc to be the exclusive distributor in China of the DC BeadTM, a
chemotherapeutic drug delivery embolic agent designed to be used in the treatment of liver cancer. Part of our obligations is to assist Biocompatibles in obtaining and maintaining regulatory approval for the DC Bead in China and to pay half of the
costs incurred in these efforts.

SCV-07, our second proprietary drug development candidate, has shown evidence of clinical efficacy in
multi-drug resistant tuberculosis and early pre-clinical data suggesting utility in a variety of viral and bacterial diseases. In a recently completed phase 1 clinical trial, SCV-07 appears to be safe and well tolerated at various single and
multiple doses.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of



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assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on
various other assumptions that we believe are reasonable. These estimates are the basis for our judgments about the carrying values of assets and liabilities, which in turn may impact our reported revenue and expenses. Actual results may differ from
these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting
estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to
occur periodically, could materially change the financial statements. We believe there have been no significant changes during the three-month and six-month periods ended June 30, 2006 to the items that we disclosed as our critical accounting
policies and estimates under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December 31, 2005, with the exception of
our estimates related to the recording of expenses for stock-based compensation.

Effective January 1, 2006, we adopted the fair value
recognition provisions of Financial Accounting Standards Board (FASB) Statement No. 123(R), Share-Based Payment, (FAS 123R). Prior to January 1, 2006, we accounted for share-based payments under the recognition and
measurement provisions of Accounting Principles Board Opinion 25 (APB 25) and related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation (FAS 123). Accordingly, we did not
recognize compensation expense in accounting for our employee stock purchase plan or our stock option plans for options to employees and directors granted with exercise prices at fair market value.

Effective January 1, 2006, we adopted FAS 123R using the modified-prospective transition method. Under this method, compensation cost recognized in
the six-month period ended June 30, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of
FAS 123. Compensation cost also includes all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of FAS 123R. Compensation cost is calculated on the date of
grant using the fair value of the option as determined using the Black Scholes method and the single option approach. The Company amortizes the compensation cost over the vesting period, which is generally four years, using the straight line
attribution method. Results for prior periods have not been restated to reflect the impact of FAS 123R.

Determining the fair value of each
option award under FAS 123R using the Black Scholes option pricing model requires the use of certain subjective assumptions. We have segregated options awards into one homogenous group for purposes of determining fair values of options. We
determined weighted average valuation assumptions for the group as follows:

Volatility  We believe the historical volatility of
our stock price is indicative of expectations about expected future stock price volatility. We estimated volatility using the historical share price performance for a time period equivalent to the expected term of the option. We also considered the
implied volatility of market traded puts and calls on our common stock, however, since these puts and calls are thinly traded, the information was not considered representative of their future estimated volatility.

Expected Term  We worked with various data points to determine the most applicable expected term. We considered the terms from option date to
exercise date and from grant date to the date estimated as the date of full exercise. In addition, we considered the vesting schedules of the options, actual exercise history, and whether or not there were different exercise characteristics amongst
distinguishable groups within the organization.

Risk-Free Interest rate  The risk free interest rate is based on the U.S. treasury
constant maturity rates with similar terms to the expected term of the option.

Dividend yield  The expected dividend yield is 0% as
we have not paid and do not expect to pay dividends in the foreseeable future.

Expected Forfeitures  We use historical data
regarding forfeitures of our options to estimate pre-vesting option forfeitures. We record stock-based compensation only for those awards that are expected to vest.

The most significant assumptions are our estimates of the expected volatility and the expected term of the award. In addition, judgment is also required in estimating the amount of share-based awards that are expected
to be forfeited. If actual conditions, events or amounts differ significantly from any of these estimates, stock-based compensation expense and its non-cash effect on our results of operations could be materially impacted. As of June 30, 2006,
unamortized compensation expense related to unvested options was approximately $5,500,000. The weighted average period over which compensation expense related to these options will be recognized is 2.2 years.



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Results of Operations

Total Revenues

Product sales were $7,910,000 and $15,699,000 for the three-month and six-month
periods ended June 30, 2006, respectively, as compared to $6,851,000 and $13,512,000 for the corresponding periods in 2005. All product sales in each period were derived from sales of ZADAXIN. The increase was attributable to a higher volume of
product sold as prices have remained stable between the 2006 and 2005 periods. Sales to customers in China for the three-month and six-month periods in 2006 accounted for approximately 91% and 92% of product sales, as compared to 91% for both such
periods in 2005.

For the three-month period ended June 30, 2006, sales to four importing agents in China accounted for approximately
44%, 21%, 14% and 14% of our product sales. For the six-month period ended June 30, 2006, sales to four importing agents in China accounted for approximately 58%, 10%, 16% and 7% of our product sales, respectively. The single largest customer
in each of these two periods was the same importing agent, but the second largest customer was not the same for each of these periods. We expect that the share of our product sales to China will vary among a small number of importing agents from
quarter to quarter.

Contract revenue was $54,000 and $144,000 for the three-month and six-month periods ended June 30, 2006,
respectively, as compared to $134,000 and $268,000 for each of the corresponding periods in 2005, all in connection with the $2,685,000 payment we received from Sigma-Tau in January 2002. This revenue is being recognized as contract revenue over the
course of the ZADAXIN hepatitis C U.S. clinical program and the period of sharing the clinical data from this program with Sigma-Tau in accordance with the performance requirements under our contract with Sigma-Tau. The decrease in contract revenue
in the 2006 periods compared to the 2005 periods is due to the extension of the contract revenue recognition period to approximately the end of August 2006.

Cost of Product Sales and Gross Margin on Product Sales

Gross margin on product sales was 83% and
81% for the three-month and six-month periods ended June 30, 2006, respectively, as compared to 83% and 84% for the corresponding periods in 2005. Gross margin was higher for the three-month period ended June 30, 2006 and in the
three-month and six-month periods ended June 30, 2005 compared to historical levels in recent corresponding periods, mostly due to lower average cost of product sold in that period. We expect cost of product sales, and hence gross margin on
product sales, to vary from period to period, depending upon the level of ZADAXIN sales, the absorption of product-related fixed costs, and any charges associated with excess or expiring finished product inventory.

Research and Development

Research
and development expenses were $3,901,000 and $7,730,000 for the three-month and six-month periods ended June 30, 2006, respectively, as compared to $3,479,000 and $6,960,000 for the corresponding periods in 2005. For the three-month period
ended June 30, 2006, the higher level of research and development expenses compared to the three months ended June 30, 2005 was primarily due to stock-based compensation expense of $210,000 following the adoption of FAS 123R in addition to
an increase in clinical trial expense of $294,000. For the six-month period ended June 30, 2006, the higher level of research and development expenses compared to the same period in 2005 was due to stock-based compensation expense of $444,000
in addition to an increase in drug process development expense of $292,000. The initiation and continuation of our current clinical development programs has had, and will continue to have, a significant effect on our research and development
expenses. Although it is not possible to determine the total cost expected to be incurred in any particular quarter for each clinical trial due to the uncertain nature of the clinical trial process, we estimate that our share of the future costs
through 2007 of the current European HCV phase 3 clinical trial will be approximately $1,600,000. In general, we expect research and development expenses to vary substantially from quarter to quarter as we pursue our strategy of initiating
additional preclinical and clinical trials and testing, acquiring product rights, and expanding regulatory activities.

Sales and
Marketing

Sales and marketing expenses were $2,843,000 and $5,675,000 for the three-month and six-month periods ended June 30,
2006, as compared to $2,432,000 and $4,760,000 for the corresponding periods in 2005. The higher level of sales and marketing expenses in the three-month period ended June 30, 2006 compared to the corresponding period in 2005 was primarily due
to stock-based compensation expense of $161,000 following the adoption of FAS 123R, increases in travel



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expenses of $83,000 and payroll related expenses of $84,000. For the six-month period ended June 30, 2006, the higher level of sales and marketing
expenses compared to the same period in 2005 was due to stock-based compensation expense of $331,000, in addition to increases in payroll related expenses of $159,000 and conference related expenses of $459,000. We expect sales and marketing
expenses to vary in the next several quarters and to increase in the next several years if we are successful in our efforts to expand our commercialization and marketing efforts.

General and Administrative

General
and administrative expenses were $2,294,000 and $4,681,000 for the three-month and six-month periods ended June 30, 2006, as compared to $1,588,000 and $3,208,000 for the corresponding periods in 2005. For the three-month period ended
June 30, 2006, the higher level of general and administrative expenses compared to the same period in 2005 was primarily due to stock-based compensation expense of $137,000 following the adoption of FAS 123R, increases in payroll related
expenses of $137,000, consulting fees of $280,000, accounting and professional fees of $83,000 and annual report related expenses of $52,000. For the six-month period ended June 30, 2006, the higher level of general and administrative expenses
compared to the same period in 2005 was due to stock-based compensation expenses of $407,000, in addition to increases in payroll related expenses of $334,000, consulting fees of $327,000, accounting and professional fees of $93,000 and annual
report related expenses of $80,000. In the near term, we expect general and administrative expenses to vary from quarter to quarter and to increase particularly due to increased audit costs and other activities related to compliance with additional
securities regulation requirements.

Interest and Investment Income and Expense

Interest and investment income was approximately $446,000 and $798,000 for the three-month and six-month periods ended June 30, 2006, as compared to
$286,000 and $519,000 for the corresponding periods in 2005. The increase was primarily due to cash balances earning interest at higher rates in the 2006 period. Interest and investment expenses were $22,000 and $63,000 for the three-month and
six-month periods ended June 30, 2006 as compared to $91,000 and $181,000 for the corresponding periods in 2005. The decrease in interest and investment expense is attributable to the repayment of $4,000,000 and $1,600,000 convertible notes in
December 2005 and March 2006, respectively.

Other Income

Other income was $7,983,000 for both the three-month and six-month periods ended June 30, 2006. The increase was primarily due to the $8,000,000
received in April 2006 for the resolution of our dispute with Schering Plough KK (SPKK) concerning clinical trials conducted in Japan with ZADAXIN.

Income Taxes

The Company expects net loss to approximately break-even for the year ended December 31, 2006. Therefore,
the Company did not record any federal or state income tax expense for the three-month and six-month periods ended June 30, 2006.

Liquidity and Capital Resources

On June 30, 2006 and December 31, 2005, we had $44,091,000 and $42,256,000,
respectively, in cash, cash equivalents and short-term investments including $696,000 and $692,000, respectively, of restricted short-term investments. We currently estimate cash, cash equivalents and short-term investments at December 31, 2006
will be approximately $38,000,000.

The short-term investments consist primarily of U.S. Treasury securities and highly liquid marketable
securities. Our restricted short-term investments relate to two letters of credit each secured by a certificate of deposit. On June 30, 2006, the letters of credit totaled $696,000 and were comprised of $633,000 under our lease agreement and
$63,000 to facilitate our value added tax filings in Europe.

Net cash provided by operating activities amounted to $3,398,000 for the
six-month period ended June 30, 2006 as compared to net cash used in operating activities in the amount of $2,928,000 in the corresponding period in 2005. The change was primarily due to net income in the 2006 period compared to net loss in the
2005 period.



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Net cash used in investing activities amounted to $187,000 for the six-month period ended June 30,
2006, as compared to net cash used in investing activities in the amount of $94,000 for the corresponding period in 2005. The change in the 2006 period was primarily due to payments on the purchase of marketable securities.

Net cash used in financing activities amounted to $1,556,000 for the six-month period ended June 30, 2006 and consisted of the repayment of a
$1,600,000 convertible note partially offset by proceeds from issuance of common stock of approximately $44,000 under our employee stock purchase plan. Net cash provided by financing activities amounted to $1,083,000 for the six-month period ended
June 30, 2005 and consisted of approximately $1,006,000 related to exercises of outstanding options under our employee stock option plans and approximately $77,000 from the issuance of common stock under our employee stock purchase plan.

We intend to give priority use of our financial resources to our clinical programs in the United States and to the continued building of
our business in China. We also believe that our current resources are sufficient to permit us to execute current development programs and to undertake certain additional product development initiatives over the next two years. However, we cannot
assure you that such funds will be sufficient, and in the event we need to raise additional funds, the unavailability or the inopportune timing of any financing could prevent or delay our long-term product development programs which would severely
hurt our business. The need, timing and amount of any such financing would depend upon numerous factors, including the level of ZADAXIN sales, the timing and amount of manufacturing costs related to ZADAXIN, the availability of complementary
products, technologies and businesses, the initiation and continuation of preclinical and clinical trials and testing, the timing of regulatory approvals, developments in relationships with existing or future collaborative parties and the status of
competitive products.

Contractual Obligations

There were no material changes in the six-month period ended June 30, 2006 to our contractual obligations as disclosed in our Form 10-K for the year ended December 31, 2005.

Off-Balance Sheet Arrangements

There were no
off-balance sheet arrangements in the six-month period ended June 30, 2006.

Risk Factors

You should carefully consider the risks described below, in addition to the other information in this report on Form 10-Q and our report on Form 10-K
for the year ended December 31, 2005, before making an investment decision. Each of these risk factors could adversely affect our business, financial condition, and operating results as well as adversely affect the value of an investment in our
common stock.

Additional clinical trials will be required for the successful commercialization of ZADAXIN and if the results of clinical trials are
not favorable, we will be unable to obtain regulatory approval for the intended indications we are evaluating.

Our ability to achieve
and sustain operating profitability depends in large part on our ability to commence, execute and complete clinical programs and obtain additional regulatory approvals for ZADAXIN and other drug candidates, particularly in the United States and
Europe. We are also dependent on our ability to increase ZADAXIN sales in China and other markets. In particular, our ability to achieve and sustain profitability will depend in large part on our ability to commercialize ZADAXIN for the treatment of
HCV or malignant melanoma in the United States and Europe.

To obtain regulatory approvals, we must, among other requirements, complete
carefully controlled and well-designed clinical trials demonstrating that a particular drug is safe and effective for the applicable disease. We cannot depend on data from prior trial results to predict or demonstrate that our potential drug
products are safe and efficacious under regulatory guidelines to qualify for commercial sale. In December 2005 and June 2006, we reported final results from our two U.S. phase 3 trials evaluating the double therapy combination of ZADAXIN and
pegylated interferon alpha to treat HCV patients who had failed previous therapy. The results from these trials did not demonstrate that ZADAXIN in combination with pegylated interferon alpha provides a statistically significant clinical benefit
when compared with pegylated interferon alpha alone. Our European partner, Sigma-Tau, is conducting a triple therapy combination (ZADAXIN plus pegylated interferon alpha and ribavirin) trial in Europe and we expect that enrollment of this trial will
be completed by year-end 2006.

The current standard of care for HCV therapy is the combination of pegylated interferon alpha with
ribavirin. This combination is not approved by the FDA or the EMEA for the treatment of non-responders, however, in clinical practice pegylated interferon alpha with ribavirin is widely used for the treatment of both treatment naïve and
non-responder HCV



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patients. The European HCV phase 3 clinical trial being conducted by Sigma-Tau has been designed to compare the efficacy of the triple combination of
ZADAXIN, pegylated interferon alpha and ribavirin with the current standard of care. The final results of the European trial will not be known before early 2008. As with the FDA, the EMEA generally requires two confirmatory phase 3 clinical trials
to support their equivalent of an NDA. Therefore, results of the current triple therapy combination trial, even if positive and statistically significant, would by themselves be insufficient to support an NDA to the EMEA, and results from a second
confirmatory phase 3 clinical trial would be needed. At this time, plans for such trial have not been made. We cannot assure you that we or our European partner, Sigma-Tau, will undertake such trial, that any clinical trial of the triple therapy
combination will yield favorable results, that we will receive approval for ZADAXIN for the treatment of HCV in Europe or the United States or for the treatment of HCV in other countries, or that we will achieve significant levels of sales. If we
are unable to do so, our business will be harmed.

In December 2005, we and Sigma-Tau announced promising interim results from a large
phase 2 clinical trial in Europe evaluating ZADAXIN in combination with dacarbazine (DTIC) chemotherapy with and without low-dose interferon alpha to treat patients with stage IV, the most advanced and imminently fatal form of, malignant melanoma.
These preliminary data show a distinct ZADAXIN dose-dependent response in combination with DTIC chemotherapy with and without low-dose interferon alpha. The trials primary endpoint is overall tumor response. Later in 2006, we expect to report
additional overall tumor response data as well as preliminary survival information. With these data, we, in collaboration with Sigma-Tau, intend to approach the FDA and the EMEA to share these data and to discuss our plans to initiate phase 3
registration trials. We cannot assure you that the final results of the phase 2 clinical trial will be favorable or support the design and initiation of phase 3 clinical trials, that we or Sigma-Tau will receive approval for the indication or that
we will achieve significant levels of sales. If we are unable to do so, our business will be harmed.

We may have difficulty in recruiting patients for
our clinical trials. Higher than anticipated patient drop out rates in our clinical trials could adversely affect trial results and make it more difficult to obtain regulatory approval.

In December 2005 and June 2006 we announced results from our two U.S. phase 3 HCV clinical trials. These clinical trials did not demonstrate that the
combination of ZADAXIN and pegylated interferon alpha provides a statistically significant clinical benefit when compared to the use of pegylated interferon alpha alone in non-responder patients. These results may make Sigma-Taus efforts to
fully recruit patients for the currently ongoing ZADAXIN phase 3 HCV triple therapy combination trial more difficult and take longer than planned. In addition, HCV clinical trials are lengthy. The trials require patient treatment for 48 weeks and a
follow-up observation period for an additional 24 weeks. Patient dropouts are expected and each of our two phase 3 HCV clinical trials in the United States enrolled more than the planned number of 500 patients, but even then dropouts were higher
than anticipated. A patient who drops out at any point in the 72 weeks of the trial is considered a failure to respond in results of the clinical trial. In general, the fewer patients who complete each trial, the higher the positive
response rate for the group of remaining ZADAXIN treated patients in such trial needs to be in order to demonstrate statistical significance. Therefore, a higher than anticipated dropout rate lowers the chances of proving statistical significance
which could adversely affect clinical trial results. Dropouts did not prevent us from completing our U.S. phase 3 HCV clinical trials, however, the European phase 3 HCV triple therapy combination trial is still enrolling patients and dropouts may
affect the ability to fully enroll the trial in a reasonable period of time and the final results of the trial.

We cannot predict the safety profile of
the use of ZADAXIN when used in combination with other drugs.

Many of our trials involve the use of ZADAXIN in combination with other
drugs. Some of these drugs, particularly pegylated interferon alpha, ribavirin, non-pegylated interferon alpha, and dacarbazine are known to cause adverse patient reactions. Even if ZADAXIN does not produce adverse side effects when used alone, we
cannot predict how it will work with other drugs, including causing possible adverse side effects not directly attributable to the other drugs that could compromise the safety profile of ZADAXIN when used in certain combination therapies.

If we do not obtain regulatory approval for ZADAXIN for the intended indications that we are evaluating, our revenues will be limited and we may never
become profitable.

Our ability to execute on our business strategy has been largely dependent on our ability to obtain regulatory
approval for the use of ZADAXIN, particularly in the United States and Europe. The regulatory approval processes in the United States and Europe are demanding and typically require 12 months or more in the United States and 18 months or more in
Europe from the date of submission of a New Drug Application (NDA). We have committed significant resources, including capital and time, to develop ZADAXIN, and intend to continue to do so, including the initiation and execution of additional
clinical trials, with the goal of obtaining such approvals. If we do not obtain these approvals, we will be unable to achieve any substantial increase in our revenue from ZADAXIN and our ZADAXIN sales in other jurisdictions could decline.

All new drugs, including our products, which have been developed or are under development, are subject to extensive and rigorous
regulation by the FDA and comparable agencies in state and local jurisdictions and in foreign countries. These



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regulations govern, among other things, the development, testing, manufacturing, labeling, storage, pre-market approval, importation, advertising, promotion,
sale and distribution of our products. These regulations may change from time to time and new regulations may be adopted.

Obtaining
regulatory approval in developing countries also is time-consuming and expensive. In some countries where we are contemplating marketing and selling ZADAXIN, the regulatory approval process often relies on prior approvals obtained in the United
States or in Europe. Without such prior approvals, our ability to obtain regulatory approvals for ZADAXIN in these countries may be delayed or prevented. In addition, to secure these regulatory approvals, we will need, among other things, to
demonstrate favorable results from additional clinical trials of ZADAXIN. Even if we are able to complete the clinical trials we have sponsored or are planning in a timely or cost-effective manner, these trials may not fulfill the applicable
regulatory approval criteria, in which case we will not be able to obtain regulatory approval in these countries, and we have experienced such difficulties and have been unable to meet such regulatory filing requirements. We cannot assure you that
we will ultimately obtain regulatory approvals in our targeted countries in a timely and cost-effective manner or at all. If we fail to obtain the required regulatory approvals to develop, market and sell ZADAXIN in countries where we currently do
not have such rights, our revenues will be limited, and our future prospects will be dependent upon our ability to in-license or to bring earlier stage products to market, any of which will require substantial financial expenditures.

Satisfaction of government regulations may take several years and the time needed to satisfy them varies substantially based on the type, complexity and
novelty of the pharmaceutical product. As a result, government regulation may cause us to delay the introduction of, or prevent us from marketing, our existing or potential products for a considerable period of time and impose costly procedures upon
our activities. Even if we obtain regulatory approval for our products, such approval may impose limitations on the indicated uses for which our products may be marketed. Unsatisfactory data resulting from clinical trials may also adversely affect
our ability to market and sell ZADAXIN in markets where it is approved for sale.

Regulatory approval is necessary to permit us to market the DC Bead in
China. If we are unable to file and secure regulatory approval in China, we will be unable to market the DC Bead in China and our future sales potential in this market could be harmed.

In June 2006, we announced our agreement with Biocompatibles International plc. (Biocompatibles) to become the exclusive distributor in China of the DC
Bead, a chemotherapeutic drug delivery embolic agent designed to be used in the treatment of liver cancer. While the DC Bead is approved in Europe for the use in the treatment of malignant hypervascularized tumors, it has not yet received regulatory
approval in China. Biocompatibles is responsible, with our assistance and financial support of 50% of all costs, for seeking and obtaining the regulatory approval for marketing the product in China. We expect that a regulatory submission could be
filed in China by Biocompatibles in 2006; however, we cannot give assurance that such submission will be prepared and filed in a timely manner or that it will be approved by the regulatory authorities. If clinical trials in China are required as
part of the regulatory process, the regulatory submission for marketing approval could be delayed for a considerable period of time, and there can be no assurance that the results of clinical trials would support a regulatory submission or that the
regulatory authorities would approve the product to be commercialized and sold in China. To the extent that there is a delay with the regulatory filing, or additional information or clinical trials are required by the regulatory authorities, or we
do not receive regulatory approval in China, our future sales potential in China could be harmed.

If we lose key personnel or are unable to attract and
retain additional, highly skilled personnel required for the expansion of our activities, our business will suffer.

We are highly
dependent upon our ability to attract and retain qualified personnel because of the specialized, scientific and worldwide nature of our business. There is intense competition for qualified management, scientific and technical personnel in the
pharmaceutical industry, and we may not be able to attract and retain the qualified personnel we need to grow and develop our business globally. In addition, we assign numerous key responsibilities to a limited number of individuals, and we would
experience difficulty in finding immediate replacements for any of them. If we were unable to attract and retain qualified personnel as needed or promptly replace those employees who are critical to our product development and commercialization, the
development and commercialization of our products would be adversely affected. At this time, we do not maintain key person life insurance on any of our personnel.

Our revenue is dependent on the sale of ZADAXIN in foreign countries, particularly China, and if we experience difficulties in our foreign sales efforts, our operating results and financial condition will be
harmed.

Our product revenue in the near term is highly dependent on the sale of ZADAXIN in foreign countries. If we experience
difficulties in our foreign sales efforts, our business will suffer and our operating results and financial condition will be harmed. In the six-month period ended June 30, 2006 and in the year ended December 31, 2005, approximately 92%
and 91%, respectively, of our ZADAXIN sales were to customers in China. For the years ended December 31, 2004 and 2003,



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sales to our customers in China accounted for approximately 91% and 88%, respectively, of product sales. Sales of ZADAXIN in China may be limited due to the
low average personal income, lack of patient cost reimbursement, poorly developed infrastructure and existing and potential competition from other products, including generics. In China, ZADAXIN is approved only for the treatment of HBV and as a
vaccine adjuvant. We face competition from certain large, global pharmaceutical companies who are aggressively marketing competing products for the treatment of HBV and other indications where ZADAXIN is used on an off-label basis. In addition,
several local companies have introduced lower priced locally manufactured generic thymosin which is a competitive product. We expect such competition to continue and there could be a negative impact on the price and the volume of ZADAXIN sold in
China, which would harm our business. Our efforts to in-license other pharmaceutical products for marketing in China and other markets may be unsuccessful or may not have a meaningful effect on our dependence on ZADAXIN sales in those markets.

Our ZADAXIN sales and operations in other parts of Asia, as well as in Latin America and the Middle East, are subject to a number of
risks, including difficulties and delays in obtaining registrations, permits, pricing approvals and reimbursement, unexpected changes in regulatory requirements and political instability. We are also subject to the laws and regulations of other
countries regarding the marketing, sale and distribution of our products in those countries where approvals have been obtained. We experience other issues with managing foreign sales operations including long payment cycles, potential difficulties
in accounts receivable collection and, especially from significant customers, fluctuations in the timing and amount of orders. Operations in foreign countries also expose us to risks relating to difficulties in enforcing our proprietary rights,
currency fluctuations and adverse or deteriorating economic conditions. If we experience problems with obtaining registrations, complying with reimbursement rules or compliance with other laws, or if we experience difficulties in payments or
intellectual property matters in foreign jurisdictions, or if significant political, economic or regulatory changes occur, our results could be adversely affected.

We do not have product sales in the United States, Europe or Japan with which to offset any decrease in our revenue from ZADAXIN sales in Asia, Latin America and the Middle East, and sales outside of China have not
been substantial to date. In addition, some countries in these regions, including China, regulate pharmaceutical prices and pharmaceutical importation. These regulations may reduce prices for ZADAXIN to levels significantly below those that would
prevail in an unregulated market, limit the volume of product which may be imported and sold or place high import duties on the product, any of which may limit the growth of our revenues or cause them to decline. In China, individual provinces and,
in some cases, individual hospitals can and have established pricing requirements for a product to be included on formulary lists. These prices may be lower than our distributors have been selling ZADAXIN in which case we have been removed from
formulary lists, which consequently has reduced sales to certain hospitals.

Because of Chinas tiered method of importing and distributing
finished pharmaceutical products, our quarterly results may vary substantially from one period to the next.

China uses a tiered method
to import and distribute finished pharmaceutical products. At each port of entry, and prior to moving the product forward to the distributors, government-licensed importing agents must process and evaluate each shipment to determine whether such
shipment satisfies Chinas quality assurance requirements. In order to efficiently manage this process, the importing agents typically place large, and therefore relatively few, orders within any six month period. Therefore, our sales to an
importing agent can vary substantially from quarter to quarter depending on the size and timing of the orders, which has in the past and may in the future cause our quarterly results to fluctuate. We rely on four to six importers, in any given
quarter, to supply substantially all of our product in China. Because we use a small number of importing agents in China, our receivables from any one importing agent are material, and if we were unable to collect receivables from any importer, our
business and cash-flow would be adversely affected.

Our sales of ZADAXIN may fluctuate due to seasonality of product orders and sales in any quarter
may not be indicative of future sales.

Our sales for the quarter ended June 30, 2003 were greatly affected by the demand in China
for ZADAXIN in connection with the treatment of SARS. To date, SARS has not re-emerged, like influenza, as a seasonal public health problem. However, if SARS or a similar epidemic were to emerge, it is not possible to predict what effect, if any,
this would have on future sales of ZADAXIN. Although we do not market ZADAXIN for use in treating such epidemic diseases, if ZADAXIN is purchased in connection with future outbreaks of seasonal viral contagions, product sales could become more
concentrated in certain quarters of the calendar year, quarterly sales levels could fluctuate and sales in any quarter may not be indicative of sales in future periods.



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If we fail to protect our products, technologies and trade secrets, we may not be able to successfully use,
manufacture, market or sell our products, or we may fail to advance or maintain our competitive position, and we have limited intellectual property protection in China.

Our success depends significantly on our ability to obtain and maintain meaningful patent protection for our products and technologies and to preserve our
trade secrets. Our pending patent applications may not result in the issuance of patents in the future. Our patents or patent applications may not have priority over others applications. Our existing patents and additional patents that may be
issued, if any, may not provide a competitive advantage to us or may be invalidated or circumvented by our competitors. Others may independently develop similar products or design around patents issued or licensed to us. Patents issued to, or patent
applications filed by, other companies could harm our ability to use, manufacture, market or sell our products or maintain our competitive position with respect to our products. Although many of our patents relating to ZADAXIN have expired,
including composition of matter patents, we have rights to other patents and patent applications relating to ZADAXIN and ZADAXIN analogues, including method of use patents with respect to the use of ZADAXIN for certain indications. Additionally, we
have received Orphan Drug designation in the United States for thymosin alpha 1, the chemical composition of ZADAXIN, for the treatment of stage IIb through stage IV malignant melanoma. If other parties develop generic forms of ZADAXIN for other
indications, including conducting clinical trials for such indications, our patents and other rights might not be sufficient to prohibit them from marketing and selling such generic forms of ZADAXIN. If other parties develop analogues or derivatives
of ZADAXIN, our patents and other rights might not be sufficient to prohibit them from marketing these analogues or derivatives.

Pharmaceutical products are either not patentable or have only recently become patentable in some of the countries in which we market or may market ZADAXIN. We do not have patent protection for ZADAXIN in China, our largest market. Other
companies market generic thymosin alpha 1 in China, sometimes in violation of our trademark or other rights which we defend by informing physicians and hospitals of the practice as well as through the limited legal recourse. Past enforcement of
intellectual property rights in many of these countries, including China in particular, has been limited or non-existent. Future enforcement of patents and proprietary rights in many other countries will likely be problematic or unpredictable.
Moreover, the issuance of a patent in one country does not assure the issuance of a similar patent in another country. Claim interpretation and infringement laws vary by nation, so the extent of any patent protection is uncertain and may vary in
different jurisdictions.

If we are involved in intellectual property claims and litigation, the proceedings may divert our resources and subject us to
significant liability for damages, substantial litigation expense and the loss of our proprietary rights.

Our commercial success
depends in part on us not infringing valid, enforceable patents or proprietary rights of third parties, and not breaching any licenses that may relate to our technologies and products. We are aware of a third-party patent that may relate to our
products and may cover a method of action used by ZADAXIN. We cannot assure you that our mechanism of action does not infringe on their claim. In addition, we may not be aware of all patents or patent applications that may impact our ability to
make, use or sell any of our potential products. For example, U.S. patent applications may be kept confidential for 12 or more months while pending in the Patent and Trademark Office, and patent applications filed in foreign countries are often
first published six months or more after filing. It is possible that we may unintentionally infringe these patents or other patents or proprietary rights of third parties. We may in the future receive notices claiming infringement from third parties
as well as invitations to take licenses under third-party patents. Any legal action against us or our collaborative partners claiming damages and seeking to enjoin commercial activities relating to our products and processes affected by third-party
rights may require us or our collaborative partners to obtain licenses in order to continue to manufacture or market the affected products and processes. Our efforts to defend against any of these claims, regardless of merit, would require us to
devote resources and attention that could have been directed to our operations and growth plans. In addition, these actions may subject us to potential liability for damages. We or our collaborative partners may not prevail in a patent action and
any license required under a patent may not be made available on commercially acceptable terms, or at all. Any conflicts resulting from the patent rights of others could significantly reduce the coverage of our patents and limit our ability to
obtain meaningful patent protection.

If other companies obtain patents with conflicting claims, we may be required to obtain licenses to
those patents or develop or obtain alternative technology to manufacture or market the affected products and processes. We may not be able to obtain any such licenses on acceptable terms or at all. Any failure to obtain such licenses could delay or
prevent us from pursuing the development or commercialization of our potential products. Our efforts to defend against any of these claims would require us to devote resources and attention that could have been directed to our operations and growth
plans.

We may need to initiate litigation, which could be time-consuming and expensive, to enforce our proprietary rights or to determine
the scope and validity of others rights. If litigation results, a court may find our patents or those of our licensors invalid or may find that we have infringed on a competitors rights. If any of our competitors have filed patent
applications in the United States which claim technology we also have invented, the Patent and Trademark Office may require us to participate in expensive interference proceedings to determine who has the right to a patent for the technology. These
actions may subject us to potential liability for damages. We or our collaborative partners may not prevail in a patent action and any license required under a patent may not be made available on commercially acceptable terms, or at all.



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We rely on third parties to supply our clinical trial and commercial products. Deficiencies in their work could delay
or harm one or more important areas of our business including our sales, clinical trials or the regulatory approval process.

We rely on
third parties, who are subject to regulatory oversight, to supply our clinical and commercial products. The manufacturing of the raw material and the processing to finished product of ZADAXIN is done in few batches in any given three-month period.
Manufacturing interruptions or failure or delay of product to meet quality assurance specifications could adversely affect shipments and recognition of sales of ZADAXIN in any period and impair our relationships with customers and our competitive
position. If sales of ZADAXIN were to increase dramatically, our third-party suppliers may not be able to supply ZADAXIN quickly enough, which could limit our ability to satisfy increased demand or could adversely affect the ability of these
suppliers to provide products for our clinical trials. Biocompatibles is the sole supplier of the DC Bead. If unanticipated deficiencies in these suppliers occur, we could experience delays in our ability to fulfill regulatory requirements which may
adversely affect our sales or prospects for regulatory marketing approvals. We have an exclusive supplier of pegylated interferon alpha for our European phase 3 HCV clinical trial and who also supplied all of the pegylated interferon used in our
U.S. phase 3 HCV clinical trials. Any recall of the manufacturing lots or similar action regarding the pegylated interferon alpha used in our clinical trials could detract from the integrity of the trial data and its potential use in future
regulatory filings.

If we are not able to establish and maintain adequate manufacturing relationships, the development and sale of our products could
be impaired.

To be successful, our products must be manufactured in commercial quantities, in compliance with stringent regulatory
requirements and at an acceptable cost. Typically we have at any time only one supplier for each phase of manufacturing of our product. Manufacturing interruptions or failure to comply with regulatory requirements could significantly delay clinical
development of potential products and reduce third-party or clinical researcher interest and support of proposed trials. These interruptions or failures could also impede commercialization of our products, including sales of ZADAXIN in approved
markets, and impair our competitive position. Any of these developments would harm our business.

We are in the process of registering a
new supplier for ZADAXIN with regulatory agencies in markets where ZADAXIN is approved for sale. We have received such registration in China. This process, quality assurance and other steps could cause delays or interruptions of supply in certain
other markets. In some countries, a manufacturing change may require additional regulatory approvals which may delay ZADAXIN marketing approvals in new markets. In addition, manufacturing, supply and quality control problems may arise as we, either
alone or with subcontractors, attempt to scale-up our manufacturing procedures. We may not be able to scale-up in a timely manner or at a commercially reasonable cost, either of which could cause delays or pose a threat to the ultimate
commercialization of our products and harm our business.

We may not be able to successfully develop or commercialize our products. We may consider
strategic alliances with other companies in efforts to broaden our product development pipeline.

While we have limited sales of ZADAXIN
in certain markets, we do not yet have regulatory approval for ZADAXIN for the key markets of the United States, Europe and Japan and, in this respect, ZADAXIN is still being developed. We recently acquired the rights to distribute the DC Bead in
China, but we must receive regulatory approval before we can commercialize this product. Our only other potential product presently is SCV-07, and it is in an earlier stage of development than ZADAXIN. We may consider and undertake various
strategies to expand our portfolio of potential products, including acquiring product candidate rights through licenses or other relationships, or through other strategic relationships including acquisitions of other companies that may have
proprietary rights to other development candidates or the capability to discover new drug candidates. Such transactions could require a substantial amount of our financial resources, or, if equity is involved, may result in substantial dilution to
current stockholders. Strategic transactions also require substantial management time and effort and are subject to various risks that could adversely affect us or our financial results.

To fully develop our products, we will need to commit substantial resources to extensive research, development, pre-clinical testing, clinical trials,
manufacturing scale-up and regulatory approval prior to the potential products being ready for sale. We cannot assure that our efforts will produce commercially viable products. We face significant technological risks inherent in developing these
products. We may also abandon some or all of our proposed products before they become commercially viable. For the DC Bead, we are obligated to pay half of the costs in our efforts to obtain regulatory approval in China. If any of our products, even
if developed and approved, cannot be successfully commercialized in a timely manner, our business will be harmed and the price of our stock may decline.

We have not yet sold any product other than ZADAXIN and our sales have been primarily in a single country, China. Our future revenue growth depends to a great extent on increased market acceptance and
commercialization of ZADAXIN in additional countries, particularly in the United States, Europe and Japan. If we fail to successfully market ZADAXIN, or if we



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cannot commercialize this drug in the United States and other additional markets, our revenue and operating results will be limited. If unexpected and
serious adverse events are reported, or if expected efficacy results are not achieved, it would have a material adverse effect on our business. Our future revenue will also depend in part on our ability to develop other commercially viable and
accepted products, such as the DC Bead. Market acceptance of our products will depend on many factors, including our ability to convince prospective customers to use our products as an alternative to other treatments and therapies and to convince
prospective strategic partners to market our products effectively and to manufacture our products in sufficient quantities with acceptable quality and at an acceptable cost. In addition, doctors must opt to use treatments involving our products. If
doctors elect to use a different course of treatment, demand for our drug products would be reduced. Failure to do any of the above will lead to an unfavorable outcome on the results of our operations.

We rely on third-party clinical investigators to conduct our clinical trials and, as a result, we may encounter delays outside our control.

We have limited experience in conducting and managing clinical trials and we rely, in part, on third parties, particularly clinical research organizations
and our development partners, to assist us in managing and monitoring clinical trials. Our reliance on these third parties may result in delays in completing, or failure to complete, these clinical trials if third parties fail to fulfill their
obligations to us.

We may need to obtain additional capital to support our long-term product development and commercialization programs.

We believe our existing resources will be sufficient to fund our operations, including anticipated clinical trials, through 2008.
However, we cannot assure you that such funds will be sufficient, or that we will attain profitable operations in that period if ever. In addition to development plans for ZADAXIN, we intend to develop other products and we may need additional funds
in the future to support such development and to support future growth and achieve profitability. If we need to raise additional funds in the future and such funds are not available on reasonable terms, if at all, our commercialization efforts may
be impeded, our revenues may be limited and our operating results may suffer.

We have a history of operating losses and an accumulated deficit. We
expect to continue to incur losses in the near term and may never achieve profitability.

We have experienced significant operating
losses since our inception, and as of June 30, 2006, we had an accumulated deficit of approximately $156 million. We expect our operating expenses to increase over the next several years as we plan to dedicate substantially all of our resources
to expanding our development, testing and marketing capabilities, and these losses may increase if we cannot increase or sustain revenue. As a result, we may never achieve profitability.

We have limited sales, marketing and distribution capabilities outside of China, which may adversely affect our ability to successfully commercialize our products.

Outside of our current principal market of China, we have limited sales, marketing and distribution capabilities, and we anticipate that we may be relying
on third-party collaborators to sell, market and distribute our products for the foreseeable future particularly in the major pharmaceutical markets of the United States, Europe and Japan should we receive regulatory approval to market our products
in those territories. If our arrangements with these third parties are not successful, or if we are unable to enter into additional third-party arrangements, we may need to substantially expand our sales, marketing and distribution force. Our
efforts to expand may not succeed, or we may lack sufficient resources to expand in a timely manner, either of which will harm our future operating results. Moreover, if we are able to further expand our sales, marketing and distribution
capabilities, we will begin competing with other companies that have experienced and well-funded operations. If we cannot successfully compete with these larger companies, our revenues may not grow and our business may suffer.

Commercialization of some of our products depends on collaborations with others. If our collaborators are not successful, or if we are unable to find future
collaborators, we may not be able to properly develop and commercialize our products.

We depend in part on our distributors and
business partners to develop or promote our drugs, and if they are not successful in their efforts or fail to do so, our business will suffer. For example, Sigma-Tau is responsible for the development and marketing of ZADAXIN in most of Europe and
Biocompatibles is primarily responsible for the efforts to obtain regulatory approval in China for the DC Bead. We generally do not have control over the amount and timing of resources that our business partners devote to our collaborative efforts,
and they have not always performed as or when expected. If they do not perform their obligations as we expect, particularly obligations regarding clinical trials, our development expenses would increase and the development or sale of our products
could be limited or delayed, which could hurt our business and cause our stock price to decline. In addition, our relationships with these companies may not be successful. Disputes may arise with our collaborators, including disputes over ownership
rights to intellectual property, know-how or technologies developed with our collaborators. We may not be able to negotiate similar additional arrangements in the future to develop and commercialize ZADAXIN or other products.



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We may lose market share or otherwise fail to compete effectively in the intensely competitive biopharmaceutical
industry.

Competition in the biopharmaceutical industry is intense, and we expect that competition will increase. Our success depends
on our ability to compete in this industry, but we cannot assure you that we will be able to successfully compete with our competitors. Increased competitive pressure could lead to intensified price-based competition resulting in lower prices and
margins, which would hurt our operating results.

We cannot assure you that we will compete successfully against our competitors or that
our competitors, or potential competitors, will not develop drugs or other treatments for our targeted indications that will be superior to ours.

If
third-party reimbursement is not available or patients cannot otherwise pay for ZADAXIN or the DC Bead, we may not be able to successfully market them.

Significant uncertainty exists as to the reimbursement status of new therapeutic products, such as ZADAXIN and the DC Bead. We cannot assure you that third-party insurance coverage and reimbursement will be available
for therapeutic products we might develop. We cannot assure you that we will be able to maintain or increase third-party payments for ZADAXIN or obtain third-party payments for the DC Bead in China. The failure to obtain or maintain third-party
reimbursement for our products would harm our business. Further, we cannot assure you that additional limitations will not be imposed in the future in the United States or elsewhere on drug coverage and reimbursement due to proposed health care
reforms. In many emerging markets where we have marketing rights to ZADAXIN, but where government resources and per capita income may be so low that our products will be prohibitively expensive, we may not be able to market our products on
economically favorable terms, if at all.

Efforts by governmental and third-party payers to contain or reduce health care costs or the
announcement of legislative proposals or reforms to implement government controls could cause us to reduce the prices at which we market our drugs, which would reduce our gross margins and may harm our business.

We may be subject to product liability lawsuits, and our insurance may be inadequate to cover damages.

Clinical trials or marketing of any of our current and potential products may expose us to liability claims from the use of these products. We currently
carry product liability insurance. However, we cannot be certain that we will be able to maintain insurance on acceptable terms, if at all, for clinical and commercial activities or that the insurance would be sufficient to cover any potential
product liability claim or recall. If we fail to have sufficient coverage, our business, results of operations and cash flows could be adversely affected.

We depend on international sales, and global conditions could negatively affect our operating results.

A large majority of
our sales are in China. Heightened tensions resulting from the current geopolitical conditions in the Middle East, North Korea and elsewhere could worsen, causing disruptions in foreign trade, which would harm our sales. In particular, our
commercial product is manufactured in Europe and distributed by us from our operations in Hong Kong. Any disruption of our supply and distribution activities due to geopolitical conditions could decrease our sales and harm our operating results.

If we are unable to comply with environmental and other laws and regulations, our business may be harmed.

We are subject to various federal, state and local laws, regulations and recommendations relating to the use, manufacture, storage, handling and disposal
of hazardous materials and waste products (including radioactive compounds and infectious disease agents), as well as safe working conditions, laboratory and manufacturing practices and the experimental use of animals. The extent of government
regulation that might result from future legislation or administrative action in these areas cannot be accurately predicted.

We do not
currently maintain hazardous materials at our facilities. While we outsource our research and development programs involving the controlled use of biohazardous materials, if in the future we conduct these programs ourselves, we might be required to
incur significant cost to comply with environmental laws and regulations. Further, in the event of an accident, we would be liable for any damages that result, and the liability could exceed our resources.



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Our stock price may be volatile, and an investment in our stock could suffer a decline in value.

The market price of our common stock has experienced, and may continue to experience, substantial volatility due to many factors, some of which we have no
control over, including:



| |  |  | progress and results of clinical trials involving ZADAXIN and SCV-07;
| | - |  | ---------------------------------------------------------------------



| |  |  | progress of ZADAXIN through the regulatory process, especially regulatory actions and the adequacy of clinical data and documentation for regulatory purposes in the United States,
Europe and Japan;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | progress of the DC Bead through the regulatory process, especially regulatory actions and the adequacy of clinical data and documentation for regulatory purposes in China;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | timing and achievement of milestones;
| | - |  | -------------------------------------



| |  |  | announcements of technological innovations or new products by us or our competitors;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | announcement and completion of corporate acquisition, merger, licensing or marketing arrangements, or sales of assets;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | government regulatory action affecting our drug products or our competitors drug products in both the United States and foreign countries;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | developments or disputes concerning patent or proprietary rights;
| | - |  | -----------------------------------------------------------------



| |  |  | changes in the composition of our management team or board of directors;
| | - |  | ------------------------------------------------------------------------



| |  |  | changes in company assessments or financial estimates by securities analysts;
| | - |  | -----------------------------------------------------------------------------



| |  |  | actual or anticipated fluctuations in our quarterly operating results;
| | - |  | ----------------------------------------------------------------------



| |  |  | changes in assessments of our internal controls over financial reporting;
| | - |  | -------------------------------------------------------------------------



| |  |  | general stock market conditions and fluctuations for the emerging growth and biopharmaceutical market sectors;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | economic conditions in the United States or abroad; and
| | - |  | -------------------------------------------------------



| |  |  | broad financial market fluctuations in the United States, Europe or Asia.
| | - |  | -------------------------------------------------------------------------

In the past, following periods of large price declines in the public market price of a companys securities, securities class action litigation has often been initiated against that company. Litigation of this
type could result in substantial costs and diversion of our attention and resources, which would hurt our business. Any adverse determination in litigation could also subject us to significant liabilities.

Substantial sales of our stock or the exercise or conversion of options or convertible securities may impact the market price of our common stock.

Our collaborative partner Sigma Tau and affiliates hold a substantial amount of our stock. The stock is freely tradeable and Sigma Tau is not under any
obligation to SciClone which would prevent it from selling some or all of the stock it holds.

Future sales of substantial amounts of our
common stock could adversely affect the market price of our common stock. Similarly, if we raise additional funds through the issuance of common stock or securities convertible into or exercisable for common stock, the percentage ownership of our
present stockholders will be reduced and the price of our common stock may fall.

Sales of our common stock by officers and directors could affect our
stock price.

Our board of directors has approved an amendment to our trading policy that permits officers and directors to enter into
trading plans that comply with the requirements of Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. Rule 10b5-1 allows corporate officers and directors to adopt written, pre-arranged stock trading plans when they do not have material,
non-public information. Using these plans, officers and directors can gradually diversify their investment portfolios, can spread stock trades out over an extended period of time to reduce any market impact and can avoid concerns about initiating
stock transactions at a time when they might be in possession of material, non-public information. As of June 30,



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2006, one director has adopted such a plan, and other directors or officers may do so in the future. We expect future sales by officers and directors either
under 10b5-1 plans or otherwise as a result of their personal financial planning. We do not believe the volume of such sales would affect our trading price; however, the market could react negatively to sales by our officers and directors, which
could affect the trading price of our stock.

Anti-takeover provisions in our charter documents and under Delaware law may make an acquisition of us,
which may be beneficial to our stockholders, more difficult.

Certain anti-takeover provisions of Delaware law and our charter documents
as currently in effect may make a change in control of our company more difficult, even if a change in control would be beneficial to our stockholders. Our charter documents contain certain anti-takeover provisions, including provisions in our
certificate of incorporation providing that stockholders may not cumulate votes, stockholders meetings may be called by stockholders only if they hold 25% or more of our common stock and provisions in our bylaws providing that the stockholders
may not take action by written consent. Additionally, our board of directors has the authority to issue 10 million shares of preferred stock and to determine the terms of those shares of stock without any further action by the stockholders. The
rights of holders of our common stock are subject to the rights of the holders of any preferred stock that may be issued. The issuance of preferred stock could make it more difficult for a third-party to acquire a majority of our outstanding voting
stock. Delaware law also prohibits corporations from engaging in a business combination with any holders of 15% or more of their capital stock until the holder has held the stock for three years unless, among other possibilities, the board of
directors approves the transaction. Our board of directors may use these provisions to prevent changes in the management and control of our company. Also, under applicable Delaware law, our board of directors may adopt additional anti-takeover
measures in the future.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results.
As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.

Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed. We have in the past
discovered, and may in the future discover, areas of our internal controls that need improvement. For example, in the quarter ended June 30, 2005, we identified a material weakness in our internal controls over financial reporting as defined in
Public Company Accounting Oversight Board (PCAOB) Standard No. 2. This material weakness related to our failure, due to our lack of familiarity with certain technical stock option accounting matters, to evaluate the correct accounting effect of
a stock price performance based option granted to our Chief Executive Officer on June 1, 2005, the date he commenced his employment. Due to the terms of this option, Accounting Principles Board Opinion No. 25 (APB 25) required the
application of variable accounting and specifically required the recognition of non-cash expense in the period that portions of the option vested or were deemed probable of vesting at the end of the reporting period. The vesting of this option is
directly determined by the price level of trading activity in our stock, and the conditions required to recognize a related non-cash expense did not occur in the interim period ended June 30, 2005. However, had the conditions required the
recognition of a non-cash expense related to this option under APB 25, our accounting procedures at June 30, 2005 would not have correctly applied APB 25. Because of the material weakness described above, management concluded that the Company
did not maintain effective internal control over financial reporting as of June 30, 2005. The Companys management identified the steps necessary to address the material weakness described above, and executed remediation plans, as
discussed in Item 4. Controls and Procedures of our September 30, 2005 quarterly report on Form 10-Q, which is incorporated herein by reference.

Any failure to implement and maintain the improvements in the controls over our financial reporting, or difficulties encountered in the implementation of these improvements in our controls, could cause us to fail to
meet our reporting obligations. Any failure to improve our internal controls to address these identified weaknesses could also cause investors to lose confidence in our reported financial information, which could have a negative impact on the
trading price of our stock.

New accounting pronouncements may impact our financial position or results of operations.

Future changes in financial accounting standards may cause adverse, unexpected fluctuations in the timing of the recognition of revenues or expenses and
may affect our financial position or results of operations. New pronouncements and varying interpretations of pronouncements have occurred with frequency and may occur in the future and this may lead to changes in our accounting policies in the
future. One such new pronouncement issued in December 2004 by the Financial Accounting Standards Board (FASB) is FASB Statement No. 123 (revised 2004), Share-Based Payment (FAS 123R). FAS 123R requires share-based payments to
employees and directors, including grants of stock options, to be recognized in the statement of operations based on their fair values. We adopted FAS 123R on January 1, 2006. Accordingly, the adoption of FAS 123Rs fair value method is
having a significant impact on our results of operations, although it will have no impact on our cash or overall financial position. In the three-month and six-month periods ended June 30, 2006, we recognized $557,000 and $1,231,000,
respectively, of stock-based compensation expense relating to the adoption of FAS 123R.



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New legislation may impact our financial position or results of operations.

Compliance with changing regulations concerning corporate governance and public disclosure has resulted in and may continue to result in additional
expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ Global Market rules, are creating uncertainty for companies such as
ours and costs are increasing as a result of this uncertainty and other factors. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to
comply with evolving standards, and this investment has and may continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.

We may be subject to currency exchange rate fluctuations, which could adversely affect our financial performance.

Substantially all of our product sales are denominated in U.S. dollars. Fluctuation in the U.S. dollar exchange rate with local currency directly affects
the customers cost for our product. In particular, a stronger U.S. dollar vis-à-vis the local currency would tend to have an adverse effect on sales and potentially on collection of accounts receivable. Through the periods ended
June 30, 2006, this exposure to currency exchange rate fluctuations had been minimal because the Chinese currency had been pegged to the U.S. dollar. However, the Chinese currency is no longer pegged to the U.S. dollar and consequently, our
foreign operations may expose us to greater risk of decreased sales due to currency exchange rate fluctuations in the future. In addition, we are subject to currency exchange rate fluctuations as a result of expenses incurred by our foreign
operations. In particular, one of our supply arrangements under which we purchase finished products is denominated in euros and costs of our marketing efforts in China are paid in local currency. Consequently, changes in exchange rates could
unpredictably and adversely affect our operating results and could result in exchange losses. To date, we have not hedged against the risks associated with fluctuations in exchange rates and, therefore, exchange rate fluctuations could have a
material adverse impact on our future operating results and stock price.



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Item 3. Quantitative and Qualitative Disclosures About Market Risk

The primary objective of our investment
activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest primarily in U.S. Treasury or U.S. government agency notes. Our investments in these notes are
subject to interest rate risk. To minimize the exposure due to an adverse shift in interest rates, we invest in short-term notes and maintain an average maturity of less than one year. A hypothetical 60 basis point increase in interest rates would
result in an approximate $149,911 decrease (0.6%) in fair value of our available-for-sale securities. This potential change is based on sensitivity analyses performed on our financial position at June 30, 2006. Actual results may differ
materially.

Substantially all our sales and most of our manufacturing costs to date have been in U.S. dollars. Our purchases from one of
our contract manufacturers, however, are denominated in euros and costs of our marketing efforts in China are paid in local currency, and this exposes us to foreign currency rate fluctuations. Consequently, changes in exchange rates could
unpredictably and adversely affect our operating results and could result in exchange losses although such losses have been minimal to date. We do not hedge against the risks associated with fluctuations in exchange rates and, therefore, exchange
rate fluctuations could have a material adverse impact on our operating results and stock price.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Financial Officer and Chief Executive Officer, we evaluated the
effectiveness of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Financial Officer and Chief Executive Officer
concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal
Controls

There has been no significant change in our internal control over financial reporting that occurred during the second quarter
of 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the
Effectiveness of Controls

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within an organization have been detected.
We continue to improve and refine our internal controls and our compliance with existing controls is an ongoing process.



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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On April 3, 2006, the Company announced the resolution of its dispute with
Schering Plough KK (SPKK) concerning clinical trials conducted in Japan with ZADAXIN. Under the terms of the settlement, SPKK paid SciClone $8,000,000, which was received on April 18, 2006.

Item 1A. Risk Factors

The only material changes in our risk factors from those previously disclosed in
our Form 10-K for the year ended December 31, 2005, were as follows:



| |  |  | We deleted our risk factor with respect to our dispute with SPKK and our plans for ZADAXIN in Japan.
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | We modified our risk factor regarding the requirement of additional clinical trials for the successful commercialization of ZADAXIN, which now reads in full as follows:
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Additional clinical trials will be required for the successful commercialization of ZADAXIN and if the results of clinical trials are not
favorable, we will be unable to obtain regulatory approval for the intended indications we are evaluating.

Our ability to achieve and
sustain operating profitability depends in large part on our ability to commence, execute and complete clinical programs and obtain additional regulatory approvals for ZADAXIN and other drug candidates, particularly in the United States and Europe.
We are also dependent on our ability to increase ZADAXIN sales in China and other markets. In particular, our ability to achieve and sustain profitability will depend in large part on our ability to commercialize ZADAXIN for the treatment of HCV or
malignant melanoma in the United States and Europe.

To obtain regulatory approvals, we must, among other requirements, complete carefully
controlled and well-designed clinical trials demonstrating that a particular drug is safe and effective for the applicable disease. We cannot depend on data from prior trial results to predict or demonstrate that our potential drug products are safe
and efficacious under regulatory guidelines to qualify for commercial sale. In December 2005 and June 2006, we reported final results from our two U.S. phase 3 trials evaluating the double therapy combination of ZADAXIN and pegylated interferon
alpha to treat HCV patients who had failed previous therapy. The results from these trials did not demonstrate that ZADAXIN in combination with pegylated interferon alpha provides a statistically significant clinical benefit when compared with
pegylated interferon alpha alone. Our European partner, Sigma-Tau, is conducting a triple therapy combination (ZADAXIN plus pegylated interferon alpha and ribavirin) trial in Europe and we expect that enrollment of this trial will be completed by
year-end 2006.

The current standard of care for HCV therapy is the combination of pegylated interferon alpha with ribavirin. This
combination is not approved by the FDA or the EMEA for the treatment of non-responders, however, in clinical practice pegylated interferon alpha with ribavirin is widely used for the treatment of both treatment naïve and non-responder HCV
patients. The European HCV phase 3 clinical trial being conducted by Sigma-Tau has been designed to compare the efficacy of the triple combination of ZADAXIN, pegylated interferon alpha and ribavirin with the current standard of care. The final
results of the European trial will not be known before early 2008. As with the FDA, the EMEA generally requires two confirmatory phase 3 clinical trials to support their equivalent of an NDA. Therefore, results of the current triple therapy
combination trial, even if positive and statistically significant, would by themselves be insufficient to support an NDA to the EMEA, and results from a second confirmatory phase 3 clinical trial would be needed. At this time, plans for such trial
have not been made. We cannot assure you that we or our European partner, Sigma-Tau, will undertake such trial, that any clinical trial of the triple therapy combination will yield favorable results, that we will receive approval for ZADAXIN for the
treatment of HCV in Europe or the United States or for the treatment of HCV in other countries, or that we will achieve significant levels of sales. If we are unable to do so, our business will be harmed.

In December 2005, we and Sigma-Tau announced promising interim results from a large phase 2 clinical trial in Europe evaluating ZADAXIN in combination
with dacarbazine (DTIC) chemotherapy with and without low-dose interferon alpha to treat patients with stage IV, the most advanced and imminently fatal form of, malignant melanoma. These preliminary data show a distinct ZADAXIN dose-dependent
response in combination with DTIC chemotherapy with and without low-dose interferon alpha. The trials primary endpoint is overall tumor response. Later in 2006, we expect to report additional overall tumor response data as well as preliminary
survival information. With these data, we, in collaboration with Sigma-Tau, intend to approach the FDA and the EMEA to share these data and to discuss our plans to initiate phase 3 registration trials. We cannot assure you that the final results of
the phase 2 clinical trial will be favorable or support the design and initiation of phase 3 clinical trials, that we or Sigma-Tau will receive approval for the indication or that we will achieve significant levels of sales. If we are unable to do
so, our business will be harmed.



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| |  |  | We modified our risk factor regarding difficulty in recruiting patients for our clinical trials, which now reads in full as follows:
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------

We may have difficulty in recruiting patients for our clinical trials. Higher than anticipated patient drop out rates in our clinical trials could adversely affect
trial results and make it more difficult to obtain regulatory approval.

In December 2005 and June 2006 we announced results from our
two U.S. phase 3 HCV clinical trials. These clinical trials did not demonstrate that the combination of ZADAXIN and pegylated interferon alpha provides a statistically significant clinical benefit when compared to the use of pegylated interferon
alpha alone in non-responder patients. These results may make Sigma-Taus efforts to fully recruit patients for the currently ongoing ZADAXIN phase 3 HCV triple therapy combination trial more difficult and take longer than planned. In addition,
HCV clinical trials are lengthy. The trials require patient treatment for 48 weeks and a follow-up observation period for an additional 24 weeks. Patient dropouts are expected and each of our two phase 3 HCV clinical trials in the United States
enrolled more than the planned number of 500 patients, but even then dropouts were higher than anticipated. A patient who drops out at any point in the 72 weeks of the trial is considered a failure to respond in results of the clinical
trial. In general, the fewer patients who complete each trial, the higher the positive response rate for the group of remaining ZADAXIN treated patients in such trial needs to be in order to demonstrate statistical significance. Therefore, a higher
than anticipated dropout rate lowers the chances of proving statistical significance which could adversely affect clinical trial results. Dropouts did not prevent us from completing our U.S. phase 3 HCV clinical trials, however, the European phase 3
HCV triple therapy combination trial is still enrolling patients and dropouts may affect the ability to fully enroll the trial in a reasonable period of time and the final results of the trial.



| |  |  | We added a risk factor regarding the necessity of regulatory approval to permit us to market the DC Bead in China, which reads in full as follows:
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------

Regulatory approval is necessary to permit us to market the DC Bead in China. If we are unable to file and secure regulatory approval in China, we will be unable to
market the DC Bead in China and our future sales potential in this market could be harmed.

In June 2006, we announced our agreement
with Biocompatibles International plc. (Biocompatibles) to become the exclusive distributor in China of the DC Bead, a chemotherapeutic drug delivery embolic agent designed to be used in the treatment of liver cancer. While the DC Bead is approved
in Europe for the use in the treatment of malignant hypervascularized tumors, it has not yet received regulatory approval in China. Biocompatibles is responsible, with our assistance and financial support of 50% of all costs, for seeking and
obtaining the regulatory approval for marketing the product in China. We expect that a regulatory submission could be filed in China by Biocompatibles in 2006; however, we cannot give assurance that such submission will be prepared and filed in a
timely manner or that it will be approved by the regulatory authorities. If clinical trials in China are required as part of the regulatory process, the regulatory submission for marketing approval could be delayed for a considerable period of time,
and there can be no assurance that the results of clinical trials would support a regulatory submission or that the regulatory authorities would approve the product to be commercialized and sold in China. To the extent that there is a delay with the
regulatory filing, or additional information or clinical trials are required by the regulatory authorities, or we do not receive regulatory approval in China, our future sales potential in China could be harmed.



| |  |  | We modified our risk factor regarding our reliance on third parties to manufacture our product, which now reads in full as follows:
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------

We rely on third parties to supply our clinical trial and commercial products. Deficiencies in their work could delay or harm one or more important areas of our
business including our sales, clinical trials or the regulatory approval process.

We rely on third parties, who are subject to
regulatory oversight, to supply our clinical and commercial products. The manufacturing of the raw material and the processing to finished product of ZADAXIN is done in few batches in any given three-month period. Manufacturing interruptions or
failure or delay of product to meet quality assurance specifications could adversely affect shipments and recognition of sales of ZADAXIN in any period and impair our relationships with customers and our competitive position. If sales of ZADAXIN
were to increase dramatically, our third-party suppliers may not be able to supply ZADAXIN quickly enough, which could limit our ability to satisfy increased demand or could adversely affect the ability of these suppliers to provide products for our
clinical trials. Biocompatibles is the sole supplier of the DC Bead. If unanticipated deficiencies in these suppliers occur, we could experience delays in our ability to fulfill regulatory requirements



33



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which may adversely affect our sales or prospects for regulatory marketing approvals. We have an exclusive supplier of pegylated interferon alpha for our
European phase 3 HCV clinical trial and who also supplied all of the pegylated interferon used in our U.S. phase 3 HCV clinical trials. Any recall of the manufacturing lots or similar action regarding the pegylated interferon alpha used in our
clinical trials could detract from the integrity of the trial data and its potential use in future regulatory filings.



| |  |  | We modified our risk factor regarding development or commercialization of our products, which now reads in full as follows:
| | - |  | ---------------------------------------------------------------------------------------------------------------------------

We may not be able to successfully develop or commercialize our products. We may consider strategic alliances with other companies in efforts to broaden our product
development pipeline.

While we have limited sales of ZADAXIN in certain markets, we do not yet have regulatory approval for ZADAXIN for
the key markets of the United States, Europe and Japan and, in this respect, ZADAXIN is still being developed. We recently acquired the rights to distribute the DC Bead in China, but we must receive regulatory approval before we can commercialize
this product. Our only other potential product presently is SCV-07, and it is in an earlier stage of development than ZADAXIN. We may consider and undertake various strategies to expand our portfolio of potential products, including acquiring
product candidate rights through licenses or other relationships, or through other strategic relationships including acquisitions of other companies that may have proprietary rights to other development candidates or the capability to discover new
drug candidates. Such transactions could require a substantial amount of our financial resources, or, if equity is involved, may result in substantial dilution to current stockholders. Strategic transactions also require substantial management time
and effort and are subject to various risks that could adversely affect us or our financial results.

To fully develop our products, we
will need to commit substantial resources to extensive research, development, pre-clinical testing, clinical trials, manufacturing scale-up and regulatory approval prior to the potential products being ready for sale. We cannot assure that our
efforts will produce commercially viable products. We face significant technological risks inherent in developing these products. We may also abandon some or all of our proposed products before they become commercially viable. For the DC Bead, we
are obligated to pay half of the costs in our efforts to obtain regulatory approval in China. If any of our products, even if developed and approved, cannot be successfully commercialized in a timely manner, our business will be harmed and the price
of our stock may decline.

We have not yet sold any product other than ZADAXIN and our sales have been primarily in a single country,
China. Our future revenue growth depends to a great extent on increased market acceptance and commercialization of ZADAXIN in additional countries, particularly in the United States, Europe and Japan. If we fail to successfully market ZADAXIN, or if
we cannot commercialize this drug in the United States and other additional markets, our revenue and operating results will be limited. If unexpected and serious adverse events are reported, or if expected efficacy results are not achieved, it would
have a material adverse effect on our business. Our future revenue will also depend in part on our ability to develop other commercially viable and accepted products, such as the DC Bead. Market acceptance of our products will depend on many
factors, including our ability to convince prospective customers to use our products as an alternative to other treatments and therapies and to convince prospective strategic partners to market our products effectively and to manufacture our
products in sufficient quantities with acceptable quality and at an acceptable cost. In addition, doctors must opt to use treatments involving our products. If doctors elect to use a different course of treatment, demand for our drug products would
be reduced. Failure to do any of the above will lead to an unfavorable outcome on the results of our operations.



| |  |  | We modified our risk factor regarding loss of market share or failure to compete effectively, which now reads in full as follows:
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------

We may lose market share or otherwise fail to compete effectively in the intensely competitive biopharmaceutical industry.

Competition in the biopharmaceutical industry is intense, and we expect that competition will increase. Our success depends on our ability to compete in
this industry, but we cannot assure you that we will be able to successfully compete with our competitors. Increased competitive pressure could lead to intensified price-based competition resulting in lower prices and margins, which would hurt our
operating results. We cannot assure you that we will compete successfully against our competitors or that our competitors, or potential competitors, will not develop drugs or other treatments for our targeted indications that will be superior to
ours.



| |  |  | We modified our risk factor regarding third-party reimbursement, which now reads in full as follows:
| | - |  | ----------------------------------------------------------------------------------------------------



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If third-party reimbursement is not available or patients cannot otherwise pay for ZADAXIN or the DC Bead, we may not
be able to successfully market them.

Significant uncertainty exists as to the reimbursement status of new therapeutic products, such as
ZADAXIN and the DC Bead. We cannot assure you that third-party insurance coverage and reimbursement will be available for therapeutic products we might develop. We cannot assure you that we will be able to maintain or increase third-party payments
for ZADAXIN or obtain third-party payments for the DC Bead in China. The failure to obtain or maintain third-party reimbursement for our products would harm our business. Further, we cannot assure you that additional limitations will not be imposed
in the future in the United States or elsewhere on drug coverage and reimbursement due to proposed health care reforms. In many emerging markets where we have marketing rights to ZADAXIN, but where government resources and per capita income may be
so low that our products will be prohibitively expensive, we may not be able to market our products on economically favorable terms, if at all.

Efforts by governmental and third-party payers to contain or reduce health care costs or the announcement of legislative proposals or reforms to implement government controls could cause us to reduce the prices at which we market our drugs,
which would reduce our gross margins and may harm our business.



| |  |  | In our risk factor regarding the volatility of our stock price, we added a factor that may cause substantial volatility of the market price of our common stock, as follows:
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our stock price may be volatile, and an investment in our stock could suffer a decline in value.

The market price of our common stock has experienced, and may continue to experience, substantial volatility due to many factors, some of which we have no
control over, including:

progress of the DC Bead through the regulatory process, especially regulatory actions and the adequacy of
clinical data and documentation for regulatory purposes in China;

Item 4. Submission of Matters to a Vote of Security Holders

We held our Annual Meeting of Stockholders on
June 13, 2006 to elect seven (7) directors, and to ratify Ernst & Young LLP as the Companys independent auditors for fiscal 2006.

At the Annual Meeting of Stockholders, all of the director nominees were elected by the following number of votes:



|                        |  |            |  |               |  |              |  |            |  |                
|----------------------- |  | ---------- |  | ------------- |  | ------------ |  | ---------- |  | ---------------
|                        |  | For        |  | VotesWithheld |  | VotesAgainst |  | Abstaining |  | Broker NonVotes
|Dean S. Woodman         |  | 28,457,476 |  | 1,445,531     |  | 0            |  | 0          |  | 0              
|John D. Baxter, M.D.    |  | 28,257,979 |  | 1,645,028     |  | 0            |  | 0          |  | 0              
|Friedhelm Blobel, Ph.D. |  | 28,488,105 |  | 1,414,902     |  | 0            |  | 0          |  | 0              
|Richard J. Hawkins      |  | 28,156,715 |  | 1,746,292     |  | 0            |  | 0          |  | 0              
|Rolf H. Henel           |  | 28,159,625 |  | 1,743,382     |  | 0            |  | 0          |  | 0              
|Ira D. Lawrence, M.D.   |  | 28,487,055 |  | 1,415,952     |  | 0            |  | 0          |  | 0              
|Jon S. Saxe             |  | 28,401,308 |  | 1,501,699     |  | 0            |  | 0          |  | 0              

Stockholders ratified the appointment of Ernst & Young LLP as the Companys
independent auditors for the fiscal year ending December 31, 2006 by the following number of votes: 29,586,696 for; 245,424 against; 70,887 abstaining; 0 withheld; and 0 broker non-votes.



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Item 6. Exhibits



|               |  |                                                                                                                                                            
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                
|3(i).1(1)      |  | Amended and Restated Certificate of Incorporation.                                                                                                         
|               | 
|3(ii).1(1)     |  | Bylaws.                                                                                                                                                    
|               | 
|4.1(2)         |  | Rights Agreement dated as of July 25, 1997 between the Registrant and Chase Mellon Shareholder Services, LLC.                                              
|               | 
|4.2(1)         |  | First Amendment to Rights Agreement dated as of July 17, 2003 between the Registrant and Mellon Investor Services LLC.                                     
|               | 
|4.3(3)*        |  | 6% Convertible Note dated as of December 7, 2000 by the Registrant in favor of UBS AG, London Branch.                                                      
|               | 
|4.4(3)*        |  | Option Agreement dated as of October 26, 2000 by and between the Registrant and UBS AG, London Branch.                                                     
|               | 
|4.5(3)*        |  | Amendment No. 1 to Option Agreement dated as of December 19, 2000 by and between the Registrant and UBS AG, London Branch.                                 
|               | 
|4.6(4)*        |  | 6% Convertible Note dated as of March 21, 2001 by the Company in favor of UBS AG, London Branch.                                                           
|               | 
|4.7(4)*        |  | Option Agreement dated as of February 16, 2001 by and between the Company and UBS AG, London Branch.                                                       
|               | 
|4.8(4)*        |  | Amendment No.1 to Option Agreement dated as of March 21, 2001 by and between the Company and UBS AG, London Branch.                                        
|               | 
|10.1(5)        |  | Employment Agreement between SciClone Pharmaceuticals, Inc. and Ira D. Lawrence, M.D. dated as of April 25, 2005.                                          
|               | 
|10.2(5)        |  | Change in Control Agreement between SciClone Pharmaceuticals, Inc. and Ira D. Lawrence, M.D. dated as of April 25, 2005.                                   
|               | 
|10.3(5)        |  | Indemnity Agreement between SciClone Pharmaceuticals, Inc. and Ira D. Lawrence, M.D. dated as of April 25, 2005.                                           
|               | 
|10.4(6)        |  | Amendment of Stock Option Agreement between SciClone Pharmaceuticals, Inc. and Jere E. Goyan, Ph.D. dated as of May 29, 2005.                              
|               | 
|10.5(6)        |  | Amendment of Stock Option Agreement between SciClone Pharmaceuticals, Inc. and Edwin C. Cadman, M.D. dated as of May 29, 2005.                             
|               | 
|10.6(7)        |  | SciClone Pharmaceuticals, Inc. 2005 Equity Incentive Plan, as effective as of June 7, 2005.                                                                
|               | 
|10.7(7)        |  | SciClone Pharmaceuticals, Inc. 2004 Outside Directors Stock Option Plan, as amended June 7, 2005.                                                          
|               | 
|10.8(8)        |  | Offer letter dated as of May 21, 2001 between SciClone Pharmaceutical International Ltd. and Hans P. Schmid.                                               
|               | 
|10.9(8)        |  | Amendment to Offer Letter dated as of February 24, 2006 between SciClone Pharmaceutical International Ltd. and Hans P. Schmid.                             
|               | 
|10.10(9)       |  | Consulting Agreement between SciClone Pharmaceuticals, Inc. and Friedhelm Blobel, Ph.D. dated as of April 23, 2006.                                        
|               | 
|10.11(9)       |  | Employment Agreement between SciClone Pharmaceuticals, Inc. and Friedhelm Blobel, Ph.D. dated as of April 23, 2006 and effective as of June 2, 2006.       
|               | 
|10.12(9)       |  | Change in Control Agreement between SciClone Pharmaceuticals, Inc. and Friedhelm Blobel, Ph.D. dated as of April 23, 2006 and effective as of June 2, 2006.
|               | 
|10.13(9)       |  | Agreement Regarding Consulting, Resignation and General Release of Claims between Registrant and Ira D. Lawrence dated as of April 23, 2006.               
|               | 
|10.14(10)      |  | Contractor Services Agreement between Registrant and Ira D. Lawrence dated as of June 2, 2006.                                                             
|               | 
|10.15(10)      |  | Indemnity Agreement between Registrant and Friedhelm Blobel, Ph.D. dated as of June 2, 2006.                                                               
|               | 
|31.1(10)       |  | Rule 13a-14(a) Certification of Chief Executive Officer.                                                                                                   
|               | 
|31.2(10)       |  | Rule 13a-14(a) Certification of Chief Financial Officer.                                                                                                   
|               | 
|32.1(10)       |  | Section 1350 Certification of Chief Executive Officer.                                                                                                     
|               | 
|32.2(10)       |  | Section 1350 Certification of Chief Financial Officer.                                                                                                     

---

|* | Certain information in this exhibit has been omitted and filed separately with the Securities and Exchange Commission pursuant to a confidential treatment request under 17 C.F.R.
Sections 200.80(b)(4), 200.83 and 230.46.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(1) | Incorporated by reference from the Companys Current Report on Form 8-K filed on July 28, 2003.
|--- | -----------------------------------------------------------------------------------------------

|(2) | Incorporated by reference from the Companys Current Report on Form 8-K filed on October 14, 1997.
|--- | --------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference from the Companys Annual Report on Form 10-K for the year ended December 31, 2000.
|--- | -------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference from the Companys Quarterly Report on Form 10-Q filed on May 15, 2001.
|--- | -------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference from the Companys Current Report on Form 8-K filed on April 29, 2005.
|--- | ------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference from the Companys Current Report on Form 8-K filed on June 1, 2005.
|--- | ----------------------------------------------------------------------------------------------

|(7) | Incorporated by reference from the Companys Current Report on Form 8-K filed on June 17, 2005.
|--- | -----------------------------------------------------------------------------------------------

|(8) | Incorporated by reference from the Companys Current Report on Form 8-K filed on February 28, 2006.
|--- | ---------------------------------------------------------------------------------------------------

|(9) | Incorporated by reference from the Companys Current Report on Form 8-K filed on April 25, 2006.
|--- | ------------------------------------------------------------------------------------------------

|(10) | Filed herewith.
|---- | ---------------



37



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##### Table of Contents

SIGNATURES

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



|                     |  |                                                                   
|-------------------- |  | ------------------------------------------------------------------
|                     |  | SCICLONE PHARMACEUTICALS, INC.                                    
|                     |  | (Registrant)                                                      
|                     | 
|Date: August 9, 2006 |  | /s/ Richard A. Waldron                                            
|                     |  | Richard A. Waldron                                                
|                     |  | Chief Financial Officer (Principal Financial & Accounting Officer)



38



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##### Table of Contents

INDEX TO EXHIBITS



|               |  |                                                                                                                                                            |  |                           
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------
|Exhibit Number |  | Exhibit                                                                                                                                                    |  | Sequentially Numbered Page
|               |  |                                                                                                                                                           
|3(i).1(1)      |  | Amended and Restated Certificate of Incorporation                                                                                                          |  |                           
|               |  |                                                                                                                                                           
|3(ii).1(1)     |  | Bylaws.                                                                                                                                                    |  |                           
|               |  |                                                                                                                                                           
|4.1(2)         |  | Rights Agreement dated as of July 25, 1997 between the Registrant and Chase Mellon Shareholder Services, LLC.                                              |  |                           
|               |  |                                                                                                                                                           
|4.2(1)         |  | First Amendment to Rights Agreement dated as of July 17, 2003 between the Registrant and Mellon Investor Services LLC.                                     |  |                           
|               |  |                                                                                                                                                           
|4.3(3)*        |  | 6% Convertible Note dated as of December 7, 2000 by the Registrant in favor of UBS AG, London Branch.                                                      |  |                           
|               |  |                                                                                                                                                           
|4.4(3)*        |  | Option Agreement dated as of October 26, 2000 by and between the Registrant and UBS AG, London Branch.                                                     |  |                           
|               |  |                                                                                                                                                           
|4.5(3)*        |  | Amendment No. 1 to Option Agreement dated as of December 19, 2000 by and between the Registrant and UBS AG, London Branch.                                 |  |                           
|               |  |                                                                                                                                                           
|4.6(4)*        |  | 6% Convertible Note dated as of March 21, 2001 by the Company in favor of UBS AG, London Branch.                                                           |  |                           
|               |  |                                                                                                                                                           
|4.7(4)*        |  | Option Agreement dated as of February 16, 2001 by and between the Company and UBS AG, London Branch.                                                       |  |                           
|               |  |                                                                                                                                                           
|4.8(4)*        |  | Amendment No. 1 to Option Agreement dated as of March 21, 2001 by and between the Company and UBS AG, London Branch.                                       |  |                           
|               |  |                                                                                                                                                           
|10.1(5)        |  | Employment Agreement between SciClone Pharmaceuticals, Inc. and Ira D. Lawrence, M.D. dated as of April 25, 2005                                           |  |                           
|               |  |                                                                                                                                                           
|10.2(5)        |  | Change in Control Agreement between SciClone Pharmaceuticals, Inc. and Ira D. Lawrence, M.D. dated as of April 25, 2005                                    |  |                           
|               |  |                                                                                                                                                           
|10.3(5)        |  | Indemnity Agreement between SciClone Pharmaceuticals, Inc. and Ira D. Lawrence, M.D. dated as of April 25, 2005                                            |  |                           
|               |  |                                                                                                                                                           
|10.4(6)        |  | Amendment of Stock Option Agreement between SciClone Pharmaceuticals, Inc. and Jere E. Goyan, Ph.D. dated as of May 29, 2005                               |  |                           
|               |  |                                                                                                                                                           
|10.5(6)        |  | Amendment of Stock Option Agreement between SciClone Pharmaceuticals, Inc. and Edwin C. Cadman, M.D. dated as of May 29, 2005                              |  |                           
|               |  |                                                                                                                                                           
|10.6(7)        |  | SciClone Pharmaceuticals, Inc. 2005 Equity Incentive Plan, as effective as of June 7, 2005                                                                 |  |                           
|               |  |                                                                                                                                                           
|10.7(7)        |  | SciClone Pharmaceuticals, Inc. 2004 Outside Directors Stock Option Plan, as amended June 7, 2005                                                           |  |                           
|               |  |                                                                                                                                                           
|10.8(8)        |  | Offer letter dated as of May 21, 2001 between SciClone Pharmaceutical International Ltd. and Hans P. Schmid                                                |  |                           
|               |  |                                                                                                                                                           
|10.9(8)        |  | Amendment to Offer Letter dated as of February 24, 2006 between SciClone Pharmaceutical International Ltd. and Hans P. Schmid                              |  |                           
|               |  |                                                                                                                                                           
|10.10(9)       |  | Consulting Agreement between SciClone Pharmaceuticals, Inc. and Friedhelm Blobel, Ph.D. dated as of April 23, 2006                                         |  |                           
|               |  |                                                                                                                                                           
|10.11(9)       |  | Employment Agreement between SciClone Pharmaceuticals, Inc. and Friedhelm Blobel, Ph.D. dated as of April 23, 2006 and effective as of June 2, 2006        |  |                           
|               |  |                                                                                                                                                           
|10.12(9)       |  | Change in Control Agreement between SciClone Pharmaceuticals, Inc. and Friedhelm Blobel, Ph.D. dated as of April 23, 2006 and effective as of June 2, 2006 |  |                           



39



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##### Table of Contents

|               |  |                                                                                                                                              |  |                           
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------
|Exhibit Number |  | Exhibit                                                                                                                                      |  | Sequentially Numbered Page
|               |  |                                                                                                                                             
|10.13(9)       |  | Agreement Regarding Consulting, Resignation and General Release of Claims between Registrant and Ira D. Lawrence dated as of April 23, 2006. |  |                           
|               |  |                                                                                                                                             
|10.14(10)      |  | Contractor Services Agreement between Registrant and Ira D. Lawrence dated as of June 2, 2006.                                               |  |                           
|               |  |                                                                                                                                             
|10.15(10)      |  | Indemnity Agreement between Registrant and Friedhelm Blobel, Ph.D. dated as of June 2, 2006.                                                 |  |                           
|               |  |                                                                                                                                             
|31.1(10)       |  | Rule 13a-14(a) Certification of Chief Executive Officer.                                                                                     |  |                           
|               |  |                                                                                                                                             
|31.2(10)       |  | Rule 13a-14(a) Certification of Chief Financial Officer.                                                                                     |  |                           
|               |  |                                                                                                                                             
|32.1(10)       |  | Section 1350 Certification of Chief Executive Officer.                                                                                       |  |                           
|               |  |                                                                                                                                             
|32.2(10)       |  | Section 1350 Certification of Chief Financial Officer.                                                                                       |  |                           

---

|* | Certain information in this exhibit has been omitted and filed separately with the Securities and Exchange Commission pursuant to a confidential treatment request under 17 C.F.R.
Sections 200.80(b)(4), 200.83 and 230.46.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(1) | Incorporated by reference from the Companys Current Report on Form 8-K filed on July 28, 2003.
|--- | -----------------------------------------------------------------------------------------------

|(2) | Incorporated by reference from the Companys Current Report on Form 8-K filed on October 14, 1997.
|--- | --------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference from the Companys Annual Report on Form 10-K for the year ended December 31, 2000.
|--- | -------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference from the Companys Quarterly Report on Form 10-Q filed on May 15, 2001.
|--- | -------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference from the Companys Current Report on Form 8-K filed on April 29, 2005.
|--- | ------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference from the Companys Current Report on Form 8-K filed on June 1, 2005.
|--- | ----------------------------------------------------------------------------------------------

|(7) | Incorporated by reference from the Companys Current Report on Form 8-K filed on June 17, 2005.
|--- | -----------------------------------------------------------------------------------------------

|(8) | Incorporated by reference from the Companys Current Report on Form 8-K filed on February 28, 2006.
|--- | ---------------------------------------------------------------------------------------------------

|(9) | Incorporated by reference from the Companys Current Report on Form 8-K filed on April 25, 2006.
|--- | ------------------------------------------------------------------------------------------------

|(10) | Filed herewith.
|---- | ---------------



40