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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 
 FORM 10-K
 [X]
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal
year ended December 31, 2003,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 
 SciClone Pharmaceuticals, Inc.
 (Exact name of Registrant as specified in its charter)
 Delaware(State or other jurisdiction of
Incorporation or organization)
    
    94-3116852(I.R.S. Employer
Identification No.)901 Mariners Island
BoulevardSan Mateo, California(Address of principal executive offices)
    
    94404(Zip Code)
 (650) 358-3456
(Registrants telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act:
None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value(Title of Class) 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [  ] The aggregate market value of the voting stock held by non-affiliates of
the Registrant was approximately $320,101,054 as of June 30, 2003, based upon
the closing sale price of the Registrants Common Stock on The NASDAQ National
Market on such date. Shares of Common Stock held by each executive officer and
director have been excluded from the calculation because such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes. As of February 20, 2004, there were 44,583,412 shares of the Registrants
Common Stock outstanding. Part III incorporates by reference from the definitive proxy statement for
the Registrants 2004 Annual Meeting of Stockholders to be filed with the
Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this Form.




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TABLE OF CONTENTS  PART IItem 1. BusinessItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission of Matters to a Vote of Security HoldersPART IIItem 5. Market for the Registrants Common Equity and Related Stockholder MattersItem 6. Selected Consolidated Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORSCONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITYCONSOLIDATED STATEMENTS OF CASH FLOWSNOTES TO CONSOLIDATED FINANCIAL STATEMENTSItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresPART IIIItem 10. Directors and Executive Officers of the RegistrantItem 11. Executive CompensationItem 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related TransactionsItem 14. Principal Accountant Fees and ServicesPART IVItem 15. Exhibits, Financial Statement Schedules and Reports on Form 8-KSIGNATURESINDEX TO EXHIBITSEXHIBIT 10.11EXHIBIT 10.12EXHIBIT 10.26EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2    Table of Contents  TABLE OF CONTENTS PAGE NO.Part IItem 1.
    
    Business
    
    
    3Item 2.
    
    Properties
    
    
    17Item 3.
    
    Legal Proceedings
    
    
    17Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    17Part IIItem 5.
    
    Market for the Registrants Common Equity and Related Stockholder Matters
    
    
    17Item 6.
    
    Selected Consolidated Financial Data
    
    
    18Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 7A.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    34Item 8.
    
    Financial Statements and Supplementary Data
    
    
    35Report of Independent Auditors
    
    
    36Consolidated Balance Sheets
    
    
    37Consolidated Statements of Operations
    
    
    38Consolidated Statements of Stockholders' Equity
    
    
    39Consolidated Statements of Cash Flows
    
    
    40Notes to Consolidated Financial Statements
    
    
    41Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    53Item 9A.
    
    Controls and Procedures
    
    
    53Part IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    54Item 11.
    
    Executive Compensation
    
    
    54Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    54Item 13.
    
    Certain Relationships and Related Transactions
    
    
    54Item 14.
    
    Principal Accountant Fees and Services
    
    
    55Part IVItem 15.
    
    Exhibits, Financial Statement Schedules and Reports on Form 8-K
    
    
    55Signatures
    
    
    
    
    59
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NOTE REGARDING FORWARD-LOOKING STATEMENTS: This Annual Report on Form 10-K 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 and net sales and levels; the timing and
outcome of clinical trials and the timing of reporting of clinical trial
results; the timing of enrollment, treatment and follow-up for our clinical
trials; the preparation and timing of our Japanese New Drug Application and
other potential New Drug Applications in the United States; projected increases
in the number of hepatitis C patients seeking treatment and re-treatment;
ZADAXINs ability to complement existing therapies; prospects for ZADAXIN and
our plans for its enhancement and commercialization; future marketing efforts
and its effect on the Companys value; our ability to expand our product
pipeline; partnering prospects for ZADAXIN; research and development and other
expense levels; future inventory levels; levels of gross margin and cost of
product sales 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 Annual Report on Form 10-K. We undertake no obligation to
revise or update publicly any forward-looking statements for any reason. 
 PART I 
 Item 1.Business Overview SciClone Pharmaceuticals, Inc. is a biopharmaceutical company engaged in
the development and commercialization of therapeutics to treat life-threatening
diseases. We are currently evaluating our lead product, ZADAXIN, in several
late stage clinical trials for the treatment of patients with the hepatitis C
virus, or HCV, the hepatitis B virus, or HBV, and certain types of cancer. Our
primary focus is the successful completion of our two ongoing ZADAXIN phase 3
HCV clinical trials in the United States. We believe the worldwide market for
HCV therapies was approximately $3 billion in 2003 and could exceed $8 billion
in 2012. If approved by the U.S. Food and Drug Administration (FDA), we expect
ZADAXIN to complement other HCV therapies and to expand the HCV market
opportunity. In addition to the HCV trials in the United States, we are also
evaluating ZADAXIN in a recently completed phase 3 HBV clinical trial in Japan,
an ongoing phase 2 malignant melanoma clinical trial in Europe with our
exclusive marketing partner for Western Europe, Sigma-Tau, two ongoing phase 2
pilot studies in the United States for the treatment of liver cancer and other
international clinical trials, particularly an ongoing HCV pilot clinical trial
in Mexico. Our other principal drug development candidate is SCV-07, a
potentially orally available therapeutic to treat viral and infectious
diseases. We are currently evaluating ZADAXIN in the United States in two
multi-center, randomized, placebo controlled and double-blinded phase 3
clinical studies for the treatment of patients with HCV who have failed
previous FDA-approved HCV therapies. The World Health Organization estimates
that more than 170 million people are infected with HCV worldwide, including,
according to Datamonitor, an estimated 10 million people in the three major
pharmaceutical markets  the United States, Europe and Japan. The National
Institutes of Health estimate that in the United States alone 4 million people
are infected with HCV. The current HCV therapy of pegylated interferon alpha in
combination with ribavirin is not effective in approximately half of all
treated patients. Our clinical trials are designed to demonstrate that ZADAXIN,
in combination with pegylated interferon alpha, is effective in treating HCV
patients who have not responded to prior HCV therapies. We completed full
enrollment of our first 500 patient phase 3 hepatitis C clinical trial in
September 2003 and expect full enrollment of our second 500 patient trial near
the end of the second quarter of 2004. We expect all patients to have completed
the 12 month therapy and six month follow-up observation period by the end of
2005. To explore ways to further improve therapy for HCV patients who have not
responded to prior therapy, we also are evaluating ZADAXIN in an HCV triple
therapy pilot clinical trial in Mexico. Interim data from this trial
demonstrate that adding ZADAXIN to the combination therapy of pegylated
interferon alpha and ribavirin increased early response rates for HCV
non-responder patients. Based on these interim results, we intend to analyze
subsequent data from this trial as well as consider future additional triple
therapy clinical studies. In June 2003, we reported results from our ZADAXIN phase 3 HBV clinical
trial in Japan. Efficacy measurements taken 12 months after the end of therapy
showed that 22% of patients receiving standard dose of ZADAXIN demonstrated a
sustained seroconversion, defined by the loss of the hepatitis B virus
e-antigen and the development of antibody to the e-antigen. Patients with 3




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chronic hepatitis B who demonstrate formation of the antibody to the
hepatitis B e-antigen are generally considered to be cured of their chronic
hepatitis B. We believe the data reported from this trial show that ZADAXIN
administered as a monotherapy would be a beneficial addition to therapies
currently available in Japan for the treatment of hepatitis B. We are preparing
for a regulatory filing for ZADAXIN in Japan and are targeting to file a
Japanese New Drug Application by the end of 2004. In Europe, we are working with Sigma-Tau for the development and
commercialization of ZADAXIN. We and Sigma-Tau intend to use data from our U.S.
phase 3 HCV clinical trials, if they are positive, to pursue regulatory
approval for ZADAXIN for this indication in Europe. In addition, Sigma-Tau is
evaluating ZADAXIN in Europe in a phase 2 malignant melanoma clinical trial. ZADAXIN has been approved for sale in China for the treatment of HBV and
by the ministries of health in over 30 other countries principally for
treatment of viral indications. ZADAXIN has not produced any reported
significant side effects or toxicities in over 6 years of commercial use and
over a decade of clinical development. ZADAXIN is a synthetic preparation of a naturally occurring peptide known
as thymosin alpha 1, generically known as thymalfasin. We have maintained
exclusive commercial and marketing rights to ZADAXIN for all indications in the
United States. We are the licensee or owner of patents relating to the use of
ZADAXIN as a therapy for HCV that do not expire until 2015 in the United States
and until 2012 in Japan and the major commercial markets in Europe. We also are
the licensee or owner of patents relating to the use of ZADAXIN in Japan as a
therapy for HBV that do not expire until 2012. In certain European countries
and in Japan, the period of patent protection may be extended by up to five
years depending on the relevant dates of patent grant and market authorization. Hepatitis C and the Limitations of the Current Standard of Care HCV is one of the worlds most prevalent blood borne chronic infectious
diseases, and there is currently no approved or available vaccine to prevent
HCV infection. The World Health Organization estimates that 170 million people
are infected with HCV worldwide, including, according to Datamonitor, 10
million in the three major pharmaceutical markets  the United States, Europe
and Japan. The National Institutes of Health estimate that in the United States
alone 4 million people are infected with HCV. We believe the worldwide market
for HCV therapies could grow from $3 billion in 2003 to over $8 billion in
2012. This projection is based on an expected significant increase in the
number of patients seeking treatment for the first time or re-treatment after
failing therapy. Following the relatively high rate of infection prior to 1990
and the slow progression of the disease, the number of individuals diagnosed
with HCV and seeking treatment for the first time is expected to increase.
Since approximately 50% of patients fail current HCV therapies, the number of
patients seeking re-treatment is also expected to increase. HCV is a systemic disease that localizes itself in the liver and for the
majority of patients, if not successfully treated, leads to more serious
complications, including cirrhosis of the liver, liver failure and liver
cancer. The American Liver Foundation estimates that the number of deaths in
the United States caused by HCV is currently between 8,000 and 10,000 annually
and may increase to 30,000 deaths annually in the next twenty years.
Frequently, people with HCV are not aware that they have the disease since
symptoms at the onset of infection are generally mild. Typically, liver damage
develops gradually over a period of as much as 20 years or more before serious
symptoms of the disease become apparent. In the United States, Europe and
Japan, many people infected with HCV acquired the disease from blood
transfusions received prior to the implementation of screening the blood supply
for HCV in the early 1990s. At this time, the only products approved by the U.S. FDA for the treatment
of hepatitis C are interferon alpha, in both standard and pegylated forms, and
the antiviral drug ribavirin, which must be used in combination with interferon
alpha. The current standard of care for HCV patients is the pegylated form of
interferon alpha used in combination with ribavirin. Interferon alpha, an
injectable drug, is a recombinant version of a natural substance the body
produces in response to viral infection. Interferon alpha helps uninfected
cells resist infection and assists in stimulation of the bodys immune system
to clear infected cells. Ribavirin is a nucleoside analogue that improves the
efficacy of interferon alpha therapy for HCV, however, ribavirin by itself has
not been shown to be effective in the treatment of HCV. Interferon alpha
therapy often induces severe toxicities, and treatment with ribavirin
introduces additional toxicities. Many patients cannot, or will not, tolerate a
complete 12 month course of interferon alpha and ribavirin at approved optimal
doses, and dose reduction of one or both drugs is commonly prescribed.
Consequently, efficacy may be reduced. Current HCV therapy of pegylated interferon alpha and ribavirin is
effective as a first course of treatment for just over half of all patients.
For patients who fail this therapy, re-treatment with pegylated interferon
alpha and ribavirin is effective for only approximately 10% of such patients.
One of the primary factors in determining the chances of successful therapy for
a patient is the strain of the hepatitis C virus infecting the patient. In the
United States, we estimate that 75%, or 3 million, of all HCV carriers are
infected with a particularly difficult to treat strain called genotype 1. Of
these carriers, we estimate that 2 million have been infected 4




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with HCV for 10 years or more and have high levels of HCV genotype 1, for
whom current therapy is even less effective, producing a sustained response in
only approximately 30% of these patients. The large majority of patients who
fail current therapy have a high viral load of HCV genotype 1. It has been
estimated that 62% of HCV carriers in Europe and 69% in Japan are infected with
genotype 1. ZADAXIN Treatment for HCV We are currently developing ZADAXIN to be used in combination with
pegylated interferon alpha to be the first FDA approved therapy specifically
for the treatment of HCV in patients who have failed therapy, commonly referred
to as non-responders. If this combination therapy is approved by the FDA, we
believe that ZADAXIN could be beneficial in combination with current therapy
(pegylated interferon alpha with or without ribavirin) as a first course of
therapy for all HCV patients. ZADAXIN is a pure synthetic preparation of
thymosin alpha 1, a natural substance that circulates in the body and is
instrumental in the immune response to viral infections and certain cancers.
After the administration of a single, standard 1.6 mg subcutaneous dosage of
ZADAXIN, the circulating levels of thymosin alpha 1 are temporarily increased
50 to 100 times its normal level in the body. Published scientific and clinical
studies have shown that ZADAXIN helps stimulate and direct the bodys immune
response to eradicate HCV, HBV, other infectious diseases and certain cancers.
ZADAXIN has not produced any reported significant side effects or toxicities in
over 6 years of commercial use and over a decade of clinical development. ZADAXIN elicits a variety of immune system responses against viruses and
cancer cells. One such response is the increase in white blood cell production
and their differentiation into CD-4 helper-cells, specifically towards
differentiation of T helper 1 cells (Th1 cells secrete cytokines such as
interleukin-2 (IL-2) and gamma interferon). Studies have shown that a
Th1-directed immune response is fundamental to the eradication of certain viral
diseases, such as HCV and HBV as well as certain cancers. Similarly, ZADAXIN helps increase the production of CD-8 and NK, or
natural killer cells, a population of cells able to directly attack and kill
virally-infected and certain cancer cells. As ZADAXIN increases Th1 cells, it
also decreases production of Th2 cytokines such as IL-4. Both of these
activities are important in an effective cellular response to an HCV infection.
Moreover, ZADAXIN reduces T-cell apoptosis, or programmed cell death, which
allows these beneficial cells to circulate for a longer period of time. ZADAXIN
also exhibits direct antiviral effects by enhancing the expression of
surface-marker proteins (antigens) on virally-infected and certain cancer
cells. These surface markers help the bodys immune system recognize and target
both virally infected and cancer cells for eradication. HCV Clinical Trials We are conducting two phase 3 HCV clinical trials involving 1,000 patients
at over 80 sites in the United States using ZADAXIN in combination with
pegylated interferon alpha as a therapy for HCV non-responder patients. These
two trials are multi-centered, randomized, placebo-controlled and
double-blinded. In September 2003, one of these trials completed full enrollment of 500
patients with no cirrhosis, or tissue damage of the liver. The other trial is
currently enrolling 500 patients with mild cirrhosis of the liver and is
expected to reach full enrollment near the end of the second quarter of 2004.
Patients with cirrhosis of the liver are generally more difficult to treat and
are more difficult to qualify for enrollment in clinical trials. In each of
the clinical trials, patients are being assigned to a 12-month course of
ZADAXIN (1.6 mg/twice a week) plus pegylated interferon alpha (180 #g/once a
week) or placebo plus pegylated interferon alpha. After completing treatment,
the patients will be followed for a six-month observation period. Primary
endpoints are a sustained virological response (SVR), defined as clearance of
the hepatitis C virus measured by PCR (polymerase chain reaction), and an
improvement in the liver histological activity index, both measured at the end
of the six-month observation period. These treatments and follow-up periods are
designed to be consistent with the FDA standard for demonstrating sustained
response to HCV therapy. We currently expect all patients to have completed therapy and the
follow-up period by the end of 2005. Successful completion of two parallel
phase 3 trials is normally necessary for regulatory approval in the United
States. Therefore, we expect to report data upon completion of both trials.
These trials are designed to provide statistically significant results, and
together represent one of the largest HCV clinical studies conducted using only
patients in the United States. The PEGASYS brand of pegylated interferon alpha is being provided for both
trials at no cost to us by F. Hoffmann La-Roche (Roche), which receives the
right to use the data resulting from the trials but does not receive any
marketing rights to ZADAXIN or the combination therapy. 5




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Published data indicate ZADAXIN in combination with pegylated interferon
alpha has the potential to benefit HCV non-responder patients. In a 12-week
dose-ranging study, we treated 31 non-responders, all with a high viral load of
genotype 1 HCV, with 3 different ZADAXIN doses (0.8 mg, 1.6 mg and 3.2 mg/twice
a week) in combination with standard dose (180 μg/once a week) pegylated
interferon alpha. The data showed an early virologic response (EVR) for
patients in each dosing regimen, ranging from 20 to 36 percent across the
groups. These data, combined with immunological parameters, showed the standard
dose (1.6 mg/twice a week) to have the best probable clinical profile. EVR is
defined as a 2 log or greater reduction in HCV RNA measured after 12 weeks of
therapy. A patient who demonstrates an EVR may or may not achieve a SVR, and
therefore EVR may not be predictive of a successful outcome, especially for a
non-responder patient. Without an EVR, a patient is highly unlikely to achieve
an SVR. In addition to the 12-week study, a pooled analysis from several previous
clinical studies showed that 22% of non-responder patients treated with a
combination of ZADAXIN and non-pegylated interferon alpha had a SVR. By
comparison, in separate studies 8-15% of non-responder patients retreated with
a combination of non-pegylated interferon alpha and ribavirin had a SVR.
Comparisons between trials conducted under various conditions are informative,
but should not be relied upon as conclusive evidence as to relative therapeutic
benefit. To explore ways to further enhance ZADAXIN therapy for HCV non-responder
patients, our licensee in Mexico is conducting a triple therapy pilot clinical
trial. Interim data from this trial demonstrate that adding ZADAXIN to the
combination therapy of pegylated interferon alpha and ribavirin increased early
response rates for HCV non-responder patients. Based on these interim results,
we intend to analyze subsequent data from this trial as well as consider future
additional triple therapy clinical studies. This study could help determine if
higher EVR rates can lead to higher SVR rates. This ongoing triple therapy pilot clinical trial plans to enroll
approximately 50 HCV non-responder patients at five sites. All of the patients
in this trial have failed to show a response to prior therapy of at least six
months of interferon in combination with ribavirin. During the course of this
trial, patients will receive 12 months of triple therapy [ZADAXIN (1.6 mg/twice
a week) in combination with pegylated interferon alpha (180 μg/once a week) and
ribavirin (800-1,000 mg/daily)] and will be measured for a sustained response
six months after completing therapy. The primary endpoint of the study is a
sustained virologic response measured at week 48 (end of therapy) and week 72
(end of observation). The secondary endpoints are normalization of ALT (a
liver enzyme) measured at week 48 and 72 and reduction in HCV load (or
concentration of the virus in the blood) measured at week 12, 24, 48, and 72. Preliminary data for this trial showed that after 24 weeks of therapy with
ZADAXIN in combination with pegylated interferon alpha and ribavirin, 41% of
the initial 22 HCV non-responder patients enrolled tested negative for HCV RNA
and 50% showed a virologic response to therapy (a 2 log or greater reduction in
the level of HCV RNA). By comparison, separate recent studies show that after
24 weeks of therapy with pegylated interferon alpha plus ribavirin
approximately 30% of HCV non-responder patients test negative for HCV RNA.
Comparisons between trials conducted under various conditions are informative,
but should not be relied upon as conclusive evidence as to relative therapeutic
benefit. Earlier data reported from our trial showed that after 12 weeks of
therapy with ZADAXIN in combination with pegylated interferon alpha and
ribavirin, 61% of the initial 23 HCV non-responder patients enrolled reported
an EVR (a 2 log or greater reduction in the level of HCV RNA) and 48% tested
negative for HCV RNA. By comparison, separate recent studies show that
pegylated interferon alpha plus ribavirin produce an EVR in approximately
15-21% of non-responders after 12 weeks of therapy. ZADAXIN Treatment for HBV HBV is another highly prevalent blood borne chronic viral infectious
disease that localizes itself in the liver. The chronic phase of the disease
often leads to liver cirrhosis and progression to liver cancer. The World
Health Organization estimates that more than 350 million people
worldwide are infected with HBV, the
vast majority of those infected are in Asia and Africa, and to a lesser extent
in the Middle East. There is a relatively low incidence of the virus in
certain countries, such as the United States and those in northern Europe.
There are effective HBV vaccines that are used worldwide, however, in many
areas of the world, particularly in Asia, HBV is transmitted from mother to
child at birth. We estimate the worldwide market for HBV therapeutics was approximately
$320 million in 2003. Compared to the current size and projected growth of the
HCV therapeutics market worldwide, we believe the HBV therapeutics market
opportunities are more modest. Based on the prevalence of HBV and the economic
demographics in these territories, we believe the most important HBV markets
are in Asia, particularly China and Japan, Southern Europe and the Middle East.
In the United States, we believe the nature of the limited hepatitis B patient
population limits the market opportunity for ZADAXIN as a monotherapy for HBV.
To enhance the use of ZADAXIN in treating HBV patients, we continue to explore
ZADAXIN in combination with other approved HBV therapies. 6




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To cure chronic HBV infection, a therapy must induce a durable
interruption of viral replication which will lead to a sustained response after
therapy has ended. This is indicated by the disappearance of the marker called
HBV e-antigen and the detection of antibody to the HBV e-antigen, a process
which is also known as HBV e-antigen seroconversion. We believe that current
HBV therapies in the United States, Europe and Japan are inadequate in safely
achieving this goal of a sustained response. In Japan, these therapies include
interferon alpha and the nucleoside analogue lamivudine. Interferon alpha, an
injected drug, is effective in producing a sustained response in approximately
40% of patients. However, many patients are unable to tolerate the recommended
four months of therapy at doses three to four times that of interferon alphas
recommended HCV therapy dose. The severe side effects frequently require dose
reduction and even termination of therapy. Lamivudine, an oral nucleoside
analogue, is effective in suppressing the virus and slowing the progression of
liver disease. However, after therapy is stopped or interrupted the virus
typically rebounds. Another concern is that prolonged use of lamivudine causes
the hepatitis B virus to mutate, sometimes to a form resistant to the drug,
making therapy even more problematic. Viral mutations are common after just one
year of therapy and there is debate among physicians concerning how long to
administer this drug. Adefovir, an oral drug recently approved in the United
States and Europe but presently not in Japan, is a nucleotide analogue that,
like lamivudine, suppresses hepatitis B viral replication while the drug is
taken. It is uncertain yet whether prolonged use of adefovir will lead to
resistant viral mutations. HBV Clinical Trials The combined data from ZADAXINs hepatitis B clinical trials in the United
States, Europe and particularly Asia have resulted in regulatory and marketing
approvals for ZADAXIN as a hepatitis B therapy in Asia, Latin America and the
Middle East. In Japan, we completed our phase 3 clinical trial using ZADAXIN as a
monotherapy for hepatitis B. This clinical trial was designed to demonstrate a
clinical benefit, measured by an analysis of a combination of safety and
efficacy data points. Similar in design to some other Japanese HBV studies,
this trial did not include an untreated group of patients. Patients received
either a standard 1.6 mg/twice a week dose of ZADAXIN or a lower 0.8 mg/twice a
week dose of ZADAXIN for six months and were observed for a period of 12 months
after ending therapy. Of the patients in this trial, 39% had failed prior
therapy with interferon alpha and 24% had severe liver fibrosis. A total of 283
patients were compliant with the 18-month protocol and qualified for evaluation
at the end of the study. No significant drug-related side effects or toxicities
were reported. At the end of the follow-up period, efficacy measurements from both arms
of the trial combined showed that 27% of patients had negative HBV viral DNA,
23% of patients demonstrated a successful interruption of viral replication,
defined as clearance of the HBV e-antigen, and 20% of patients demonstrated a
sustained seroconversion of the HBV e-antigen to HBV e-antibody. Patients with
chronic HBV who demonstrate a sustained seroconversion after therapy and
follow-up observation are widely considered to be cured of their chronic HBV.
In the standard 1.6 mg arm of the trial, 29% of patients had negative HBV viral
DNA, 23% of patients demonstrated a successful interruption of viral
replication and 22% of patients demonstrated a sustained seroconversion of the
HBV e-antigen. In the lower dose 0.8 mg arm of the trial, 26% of patients had
negative hepatitis B viral DNA, 23% of patients demonstrated a successful
interruption of viral replication and 19% of patients demonstrated a sustained
seroconversion of the HBV e-antigen. We believe the results of this study compare favorably to the published
data from other approved HBV therapies. Lamivudine produced a seroconversion of
the HBV e-antigen in 16% of Asian patients after 12 months of therapy in a
trial which did not have a follow-up observation period. In a separate study,
adefovir dipivoxil produced a seroconversion of the HBV e-antigen in 12% of
patients after 12 months of therapy (no follow up observation period). The
lamivudine and adefovir dipivoxil studies had different treatment regimens from
our Japanese trial. Comparisons between trials conducted under various
conditions are informative, but should not be relied upon as conclusive
evidence as to relative therapeutic benefit. We are preparing for the filing of the JNDA, or Japanese New Drug
Application, and are targeting to have it filed by the end of 2004. We have
closed all 49 sites and are using the final data set to prepare the JNDA. The
new drug approval process in Japan involves several levels of review by the
Japanese Ministry of Health before safety and efficacy data are presented to
the medical reviewers of the Ministrys Evaluation and Licensing Division. If
the safety and efficacy review is successful, the Ministry of Economy evaluates
comparable pricing information before establishing a reimbursement price for a
drug. This entire process is demanding and typically requires 18 months or more
from the date of submission of a JNDA. We are the licensee or owner of patents
in Japan relating to the use of ZADAXIN to treat HBV that expire in 2012 and
which may be extended by up to five years depending on the relevant dates of
patent grant and market authorization. In 1994, Alpha 1 Biomedicals Inc., from which we acquired certain rights
to thymosin alpha 1, completed their 99 patient U.S. phase 3 clinical trial of
thymosin alpha 1 as a monotherapy for HBV. After six months of therapy and six
months of follow up observation, 25% of patients treated with thymosin alpha 1
achieved the endpoints of the study, negative HBV DNA and loss of the 7




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hepatitis B e-antigen, compared to 13% of patients in the placebo control
arm. Although nearly twice the number of patients treated with thymosin alpha
1 achieved the endpoints versus the placebo control arm, the small number of
patients did not provide enough power to achieve statistical significance.
Consequently, Alpha 1 Biomedicals Inc. never submitted these data to the FDA.
Thymosin alpha 1 scientific data published subsequent to 1994 have allowed us
to improve the design of our clinical trials, which we believe will lead to
more definitive results. Hepatitis Advisory Board Our Hepatitis Advisory Board provides advice for the research and clinical
development of ZADAXIN. The Board includes highly respected thought leaders in
the field of hepatology. As of December 31, 2003, the members of our Hepatitis
Advisory Board included the following: Name
    
    InstitutionJules Dienstag, M.D.
    
    Harvard University, Massachusetts General HospitalMichael Karin, Ph.D.
    
    University of California, San DiegoWillis Maddrey, M.D.
    
    University of Texas Southwestern Medical Center at DallasJohn McHutchinson, M.D.
    
    Duke University Medical CenterEugene Schiff, M.D.
    
    University of Miami School of MedicineTeresa Wright, M.D.
    
    UCSF, Veterans Administration Medical Center, GI Center,
San Francisco
 ZADAXIN Treatment in Oncology We believe that ZADAXINs mechanism of action and highly specific role in
activating and directing an immune response make it a potential therapeutic
agent for various cancers, including malignant melanoma and liver cancer. Malignant melanoma is one of the deadliest forms of cancer. There are
50,000 new melanoma cases diagnosed annually in the United States and Europe
and the median survival for late-stage malignant melanoma patients is only five
months. Current malignant melanoma therapies include interferon alpha and the
chemotherapy drug dacarbazine (DTIC). Our partner in Europe, Sigma-Tau, is currently enrolling patients in a
phase 2 malignant melanoma clinical trial intended to involve over 65 sites
throughout Europe. The trial is designed to demonstrate a clinical benefit from
using ZADAXIN in combination with standard chemotherapy and low-dose interferon
alpha. This clinical trial is being funded and conducted by Sigma-Tau, which
has exclusive marketing rights for ZADAXIN in most Western European countries.
Sigma-Tau is currently enrolling stage 4 (metastatic) malignant melanoma
patients and plans to enroll over 300 patients in this trial. All patients in
this four-arm study are receiving DTIC chemotherapy. In addition to receiving
DTIC, each patient is randomly assigned to receive either ZADAXIN, interferon
alpha, or ZADAXIN (in varying doses) plus interferon alpha. Patients are
receiving six months of therapy and will be observed for a period of 12 months
after the end of therapy. The endpoints are tumor response and survival. The
results of this clinical trial, if positive, are expected to be used in the
design of a ZADAXIN combination therapy phase 3 clinical trial for malignant
melanoma. We are also conducting two phase 2 pilot studies to explore the use and
effectiveness of ZADAXIN in the treatment of hepatocellular carcinoma (HCC), or
primary liver cancer. We estimate there are approximately 5,000 new cases of
liver cancer diagnosed annually in the U.S. Due to the relatively low
incidence of this disease and the transplant criteria for liver cancer patients
established by the United Network for Organ Sharing (UNOS) Organ Procurement
and Transplantation Network (OPTN), the rate of patient recruitment for our
trials has been slow. However, we believe that recent changes by the UNOS/OPTN
to the transplant criteria for liver cancer patients may facilitate enrollment.
We are following the tumor response and survival of the enrolled patients. SCV-07 Our other principal product development candidate is SCV-07, a potentially
orally administered therapeutic to treat viral and infectious diseases. We
acquired the worldwide rights, except in Russia, to a new class of
immunomodulators that stimulate the immune system in a manner similar to
ZADAXIN. SCV-07 is the lead candidate in this group and has been used in
clinical trials in Russia for the treatment of tuberculosis and has
demonstrated promising results. We are working with our collaborator Verta,
Ltd. in Russia to develop an oral formulation for SCV-07. We are seeking to
conduct additional clinical trials to test the optimal dosing and oral
administration of SCV-07 in the treatment of infectious diseases with the
intention of opening an Investigational New Drug application (IND) to study
SCV-07 in the United States. 8




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Our Strategy Our objective is to be a leader in the development and commercialization of
novel drugs that can be effective primarily in the treatment of infectious
diseases and cancer. We focus our financial resources on the late-stage
development of products rather than devoting these resources to discovery. In
doing so, we leverage the resources and expertise of third party
organizations, such as clinical research organizations and contract
manufacturers. Our international sales operations contribute positive cash
flow to help fund product development and targeted expansion of our marketing
efforts. Our specific near term plans include:  Obtaining regulatory approvals for ZADAXIN in the United States,
Europe and Japan.We are conducting late-stage clinical trials for
ZADAXIN targeting regulatory approval in the major pharmaceutical
markets. In the United States, we are conducting two ZADAXIN phase 3
HCV clinical trials and intend to use the data from these trials, if
favorable, to pursue regulatory approvals in the United States, Europe
and Japan. Similarly, we intend to pursue clinical development, obtain
regulatory approvals and commercialize ZADAXIN in the European Union
(EU), initially in HCV and cancer, through our marketing and development
partner, Sigma-Tau. In Japan, we intend to use the data from our ZADAXIN
phase 3 HBV clinical trial to pursue regulatory approval in that
country. We will continue to seek approvals and expand marketing
opportunities for our products in important markets in the developing
world through our wholly-owned international subsidiary, SciClone
Pharmaceuticals International Ltd. (SPIL) and believe regulatory
approvals in the major markets would benefit our efforts in the
developing world.  Introducing ZADAXIN in the major pharmaceutical markets and expanding
current international sales.In the United States, we have retained all
of the commercialization rights to ZADAXIN. We will continue to evaluate
a number of strategic options for commercializing this product if it is
approved by the FDA, including developing or contracting a professional
sales force or licensing certain rights to ZADAXIN to a pharmaceutical
company. Sigma-Tau is our exclusive ZADAXIN marketing and development
partner for most of Western Europe and Schering-Plough is our exclusive
ZADAXIN marketing partner in Japan. We intend to continue to expand
sales of ZADAXIN worldwide by seeking approvals in new markets and
seeking expanded approvals in existing markets.  Enhancing the use of ZADAXIN through new delivery technologies.We
intend to identify and develop new delivery technologies for ZADAXIN in
order to enhance its use as a treatment for HCV in combination with
current and future therapies.  Expanding product pipeline by in-licensing or acquiring new products.
We intend to further leverage our core expertise in immunology and
cancer product development by selectively in-licensing or acquiring
product development candidates in the areas of infectious disease and
cancer. We specifically focus on in-licensing or acquiring products in
pre-clinical or later stages of development that we can better exploit
through our development expertise. We also intend to further leverage
our international sales capabilities by selectively in-licensing,
acquiring, co-promoting or co-marketing products in selected markets. Intellectual Property and Proprietary Rights Patents An important element of our product development strategy is to seek
regulatory approval for our products for indications with significant market
potential and where we have a strong proprietary position through patents
covering use, process, or composition of matter of our products. For our lead
product ZADAXIN, we are the licensee or owner of patents relating to the use of
thymosin alpha 1 for certain diseases and its process of manufacture. We are the exclusive licensee or owner of patents relating to the use of
ZADAXIN as a therapy for HCV that do not expire until 2015 in the United States
and until 2012 in Japan and the major commercial markets in Europe. We also are
the licensee or owner of patents relating to the use of ZADAXIN in Japan as a
therapy for HBV that do not expire until 2012. In addition, patents relating
specifically to the use of thymosin alpha 1 in treating HCV in non-responders
to interferon alpha treatment have been issued to us in the United States and
various international markets. In certain European countries and in Japan, the
period of patent protection may be extended by up to five years depending on
the relevant dates of patent grant and market authorization, and we may,
depending on the timing of any future approval, be eligible for such an
extension. 9




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We are the exclusive licensee or owners of patents that have been issued
in the United States, Japan, China and other international markets relating to
the treatment of HBV using thymosin alpha 1. We are also the exclusive licensee
of patents that have been issued in the United States, a majority of European
countries, Japan, and other international markets that relate to the use of
thymosin alpha 1 to treat small cell and non-small cell lung cancer. Several
corresponding additional patent applications have been issued or patent
applications are pending in other countries for each of the above named
indications. For process patents, we are either a patentee or exclusive licensee of use
and process patents related to the method of making and therapeutic uses of
thymosin alpha 1. Our process patents are directed to methods of making
thymosin alpha 1 and have been issued in the United States, a majority of
European countries, Japan, Canada, Hong Kong, Taiwan and South Korea. Although
the composition of matter patents related to thymosin alpha 1 have expired in
the major pharmaceutical markets, we have several composition of matter patents
and applications directed to analogues and derivatives of thymosin alpha 1
which have been granted in the United States and in important international
markets. Our commercialized product, and the product we are using in our
clinical trials, is thymosin alpha 1 and not an analogue or derivative.
However, we continue to seek additional proprietary rights relating to the use
of thymosin alpha 1. We are the exclusive licensee of an issued U.S. patent
relating to the composition of matter of SCV-07 and related compounds, as well
as similar pending foreign patent applications. Proprietary Rights In addition to our patent protection, we intend to use other means to
protect our proprietary rights. We may pursue marketing exclusivity periods
that are available under regulatory provisions in certain countries including
the United States, Europe and Japan. Orphan drug protection has been or may be sought where available if such
protection also grants additional market exclusivity. We hold an orphan drug
product designation for thymosin alpha 1 for hepatocellular carcinoma, HBV, and
DiGeorge Anomaly in the United States and for hepatocellular carcinoma in
Europe. We have filed trademark applications worldwide for ZADAXIN and other
trademarks that appear on our commercial packaging and promotional literature.
Copyrights for the commercial packaging may prevent counterfeit products or
genuine but unauthorized products from entering a particular country by
parallel importation. We have also implemented anti-counterfeiting measures on
commercial packaging and plan to register the packaging with customs
departments in countries where such procedures exist. We also rely upon trade
secrets, which we seek to protect in part by entering into confidentiality
agreements with our employees, consultants, corporate partners, suppliers and
licensees. Marketing and Sales We or our distributors on our behalf have received from the ministries of
health approvals to market and sell ZADAXIN in over 30 countries primarily in
Asia, the Middle East and Latin America. ZADAXINs approvals are principally
for the treatment of HBV and also in certain countries for the treatment of
HCV, as a vaccine adjuvant or as a chemotherapy adjuvant for cancer patients
with weakened immune systems. In addition, we are currently conducting clinical
trials and, if successful, will pursue regulatory approvals in the United
States, Europe and Japan, which, if obtained, would allow us to market and sell
ZADAXIN in those markets. We currently sell ZADAXIN in various international markets, particularly
China, through SPIL. SPIL is registered in the Cayman Islands, headquartered in
Hong Kong has and has representative offices in Beijing, Hong Kong, Sao Paulo,
Shanghai and Singapore. SPIL orders ZADAXIN from our European manufacturer and
contracts with a third party for the storage of our finished goods inventory at
warehousing facilities in Hong Kong. SPIL then distributes our product
worldwide from these warehousing facilities based on purchase orders from our
customers. Under our established distribution arrangements, local importers and
distributors are responsible for the importation, inventory, distribution and
invoicing of ZADAXIN. Our largest single market for ZADAXIN is currently China, which accounted
for 88%, 88% and 89% of ZADAXIN sales for the years ended December 31, 2003,
2002 and 2001, respectively. China is the worlds most populous nation and also
has the largest population of HBV, HCV and liver cancer patients. Health care programs and insurance in China and other developing countries
generally do not reimburse patients for relatively expensive therapies such as
ZADAXIN and consequently the drug has been used by patients mostly on a private
payment basis in these countries. 10




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In China, SPIL sells ZADAXIN to well-established, government licensed
importing agents. Sales are made on a no returns basis, except under limited
terms regarding product quality. These importing agents in turn sell ZADAXIN to
licensed distributors who then distribute ZADAXIN to hospital pharmacies and
physicians throughout the country. In addition to its Hong Kong office, SPIL
also operates representative offices in Beijing and Shanghai, and employs a
medical education team of approximately 63 full time employees in China to
promote physicians knowledge and use of ZADAXIN. In China and the other markets where ZADAXIN is approved and actively
marketed, our marketing activities include providing ZADAXIN-related medical
education, clinical experience programs and participation in regional and
international liver disease related medical conferences. When appropriate,
these programs will extend into other markets where ZADAXIN has regulatory
approval. In the United States, we currently are conducting phase 3 clinical trials
for the treatment of HCV patients who have failed previous HCV therapies. If
these clinical trials are successful we intend to seek FDA approval. We
estimate there are approximately 3,000 hepatologists and gastroenterologists
that treat hepatitis C patients in the United States. We believe that
approximately 50 professional sales representatives could effectively market
ZADAXIN to this physician group. We believe that we would be able to execute
this strategy or other options, including co-promotion, co-marketing or
licensing arrangements, which could be similarly attractive. Sigma-Tau is our exclusive marketing and development partner for ZADAXIN
for 18 European countries. As part of our collaborative agreement, we have
agreed to provide our U.S. HCV phase 3 clinical trial data to Sigma-Tau to
assist their efforts in obtaining regulatory approval in the EU for ZADAXIN in
HCV therapy. In addition, Sigma-Tau intends to seek EU regulatory approval for
ZADAXIN for other indications and is currently conducting and funding a large
phase 2 clinical trial using ZADAXIN in combination therapy for malignant
melanoma. In Japan, we completed our phase 3 clinical trial for ZADAXIN as a
monotherapy for HBV, and we interpret the data from this trial as positive. We
have begun the preparation process for a Japanese New Drug Application.
Schering-Plough is our exclusive marketing partner for ZADAXIN in Japan. Manufacturing ZADAXIN is manufactured for us by third parties under exclusive contract
manufacturing and supply agreements. We closely monitor production runs of
ZADAXIN and regularly conduct our own quality assurance audit programs. We
believe the manufacturing facilities of our contract suppliers are in
compliance with the FDAs current Good Manufacturing Practices, and the
Japanese or European equivalents of such standards. For our phase 3 clinical trials in the United States and Japan, ZADAXIN is
manufactured by our contract suppliers in the United States. For our phase 2
clinical trial in Europe and for sale in other international markets where
approved, ZADAXIN is manufactured by our contract suppliers in Europe. In the event of the termination of an agreement with any single supplier,
we believe that we would be able to enter into arrangements with similar terms
with other suppliers. We do not intend to acquire or establish our own
dedicated manufacturing facilities for any of our products at this time. We
believe that our current manufacturing partners have enough manufacturing
capacity to meet potential market demand should ZADAXIN be approved in the
United States, Europe and Japan. Competition Our competitors include biopharmaceutical companies, biotechnology firms,
universities and other research institutions, both in the United States and
abroad, that are actively engaged in research and development of products in
the therapeutic areas we are pursing, particularly HCV, HBV and cancer.
Competitors are currently marketing drugs for HCV, HBV and cancer, or have
products in clinical trials. We believe that the principal competitive factors
in this industry include the efficacy, safety, price, therapeutic regimen,
manufacturing, quality assurance, patents associated with a given drug and
marketing capabilities. Most of our competitors, particularly large biopharmaceutical companies,
have substantially greater financial, technical, regulatory, manufacturing,
marketing and human resource capabilities than we do. Most of them also have
extensive experience in undertaking the pre-clinical and clinical testing and
in obtaining the regulatory approvals necessary to market drugs. Additional
mergers and acquisitions in the pharmaceutical industry may result in even more
resources being concentrated with our competitors. Where comparable products
are marketed by other companies, price is a competitive factor. In China, our
largest market, generic versions of thymosin alpha 1 are marketed by local
manufacturers and distributors at typically significantly less cost to the
patient. 11




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At this time, the only products approved by the U.S. FDA for the treatment
of hepatitis C are interferon alpha, in both standard and pegylated forms, and
ribavirin, which must be used in combination with interferon alpha. There are
currently two versions of pegylated interferon alpha being marketed, one by
Schering-Plough under the trade name Peg-Intron, the other by Roche under the
trade name PEGASYS. Schering-Plough markets ribavirin under the trade name
Rebetol and Roche sells a separate brand of ribavirin under the trade name
COPEGUS. In the United States, our product ZADAXIN is being evaluated in
combination with pegylated interferon alpha for the treatment of hepatitis C
patients who have failed to respond to prior therapy with interferon alpha
(pegylated or non-pegylated) plus ribavirin or with either form of interferon
alpha alone. We intend to position ZADAXIN as a complementary rather than
competitive drug to many of these therapies, although we may not be successful.
Other companies are researching, developing, or marketing other products for
use alone or in combination with interferon alphas or pegylated interferon
alphas for clinical indications including HCV and HBV. Such competitive
products include ribavirin, allegedly improved ribavirin molecules and other
products not yet in late stage clinical trials such as therapeutic vaccines,
protease, polymerase and reverse transcriptase inhibitors. In addition, we
expect continuing advancements in and increasing awareness of the use of immune
system enhancer therapy to fight cancer and infectious diseases and that this
development may create new competitors. Future clinical trials may or may not
show ZADAXIN to have advantages or clinically significant synergistic value
over such existing or future competitive products. For the treatment of HBV, current therapies being marketed by competitors
include interferon alpha, marketed by several companies, nucleoside analogues
such as lamivudine, marketed by GlaxoSmithKline PLC, and the nucleotide
analogue adefovir, marketed by GlaxoSmithKline and Gilead Sciences, Inc. In
previous clinical studies, ZADAXIN as a monotherapy has demonstrated up to the
same efficacy as interferon alpha without producing adverse side effects.
Moreover, in small pilot studies ZADAXIN in combination with interferon alpha
or lamivudine has demonstrated significantly higher efficacy rates than those
drugs used alone and without producing additional side effects. Interferon
alpha and ZADAXIN are intended to cure HBV by inducing a durable interruption
of viral replication which will lead to a sustained response. Nucleoside
analogues, nucleotide analogues and several therapies currently under
development are intended to suppress HBV viral replication while taking the
therapy, but the virus typically rebounds after therapy is stopped. Employees As of December 31, 2003, we had 105 employees, 27 in the United States and
78 in foreign offices. From time to time, we engage the services of consultants
worldwide with pharmaceutical and business backgrounds to assist in our product
development and ZADAXIN commercialization activities. We plan to leverage our
key personnel by continuing to make extensive use of clinical research
organizations, contract laboratories, development consultants and
collaborations with pharmaceutical companies to develop and market our
products. Government Regulation Regulation by governmental authorities in the United States and foreign
countries is a significant factor in the manufacturing and marketing of our
products, as well as in ongoing research and development activities and in
pre-clinical and clinical trials and testing related to our products. When our
products are manufactured, tested or sold in the United States, they will be
regulated in accordance with the Federal Food, Drug, and Cosmetic Act, commonly
referred to as the FD&C Act and the U.S. Public Health Service Act. In addition
to obtaining FDA approval for each product, each manufacturing establishment
must be registered with the FDA. Manufacturing establishments are subject to
inspections by the FDA and by other federal, state and local agencies and must
comply with current U.S. Good Manufacturing Practices (cGMP). In complying with
cGMP standards, manufacturers must continue to expend time, money and effort in
the area of production and quality control to ensure full technical compliance. The steps required before a new drug or biological product may be
distributed commercially in the United States generally include:  conducting appropriate pre-clinical laboratory evaluations, including
animal studies, in compliance with the FDAs Good Laboratory Practice
(GLP) requirements, to assess the potential safety and efficacy of the
product, and to characterize and document the products chemistry,
manufacturing controls, formulation and stability;  submitting the results of these evaluations and tests to the FDA,
along with manufacturing information and analytical data, in an
Investigational New Drug Application (IND), and receiving approval from
the FDA that the studies proposed under the IND are allowed to proceed; 12




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 obtaining approval of Institutional Review Boards (IRBs) to introduce
the drug into humans in clinical studies;  conducting adequate and well-controlled human clinical trials in
compliance with the FDAs Good Clinical Practice (GCP) requirements that
establish the safety and efficacy of the drug product candidate for the
intended use, typically in the following three sequential, or slightly
overlapping stages:  Phase 1:The drug is initially introduced into healthy human
subjects or patients and tested for safety, dose tolerance, absorption,
metabolism, distribution and excretion;  Phase 2:The drug is studied in patients to identify possible
adverse effects and safety risks, to determine dose tolerance and the
optimal dosage and to collect initial efficacy data;  Phase 3:The drug is studied in an expanded patient population at
multiple clinical study sites, to confirm efficacy and safety at the
optimized dose, by measuring a primary endpoint established at the
outset of the study, and comparing it to that of established therapies,
if any; and when required,  Phase 4:The drug is studied in an expanded patient population in a
post-approval setting for continued monitoring of safety and sometimes
continued efficacy;  submitting to the FDA the results of pre-clinical studies, clinical
studies, and adequate data on chemistry, manufacturing and control
information to ensure reproducible product quality batch after batch in
a New Drug Application (NDA) or Biologics License Application (BLA); and  obtaining FDA approval of the NDA or BLA, including inspection and
approval of the product manufacturing facility as compliant with cGMP
requirements, prior to any commercial sale or shipment of the
pharmaceutical agent. When used in connection with trials and filings in other countries, terms
such as phase 1, phase 2, phase 3, phase 4, new drug application and
marketing application refer to what we believe are comparable trials and
filings in these other countries. The process of obtaining regulatory approval is lengthy, uncertain, and
requires the expenditure of substantial resources. After FDA approval has been obtained, the FDA will require post-marketing
reporting to monitor the side effects of the drug. Further studies may be
required to provide additional data on the products risks, benefits, and
optimal use, and will be required to gain approval for the use of the product
as a treatment for clinical indications other than those for which the product
was initially tested. Results of post-marketing programs may limit or expand
the further marketing of the product. Further, if there are any modifications
to the drug, including changes in indication, labeling, or a change in the
manufacturing process or manufacturing facility, a NDA or BLA supplement may be
required to be submitted to the FDA. Additionally, after the FDA has authorized a drug product to enter
commercial distribution, numerous regulatory requirements apply. These include,
among others, the cGMPs, which require manufacturers to follow extensive
design, testing, control, documentation and other quality assurance procedures
during the manufacturing process; labeling regulations; the FDAs general
prohibition against promoting drug products for unapproved or off-label uses;
and adverse event reporting regulations, which require that manufacturers
report to the FDA if their drug may have caused or contributed to a death or
serious injury. The FDA has broad post-market and regulatory and enforcement
powers. Failure to comply with the applicable U.S. drug regulatory requirements
could result in, among other things, warning letters, fines, injunctions,
consent decrees, civil penalties, refunds, recalls or seizures of products
(which would result in the cessation or reduction of production volume), total
or partial suspension of production, withdrawals or suspensions of current
product applications and criminal prosecution. Adverse events related to our
products in any of our existing or future markets could cause regulatory
authorities to withdraw market approval for such products, if any. The FD&C Act includes provisions intended to facilitate and expedite the
development and review of drugs and biological products intended for treatment
of serious or life-threatening conditions that demonstrate the potential to
address unmet medical needs for such conditions. These provisions set forth a
procedure for designation of a drug as a fast track product. Concurrent with
or after an IND is filed, the sponsor may request designation as a fast track
product, and the FDA is required to respond within 60 days. 13




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An advantage of fast track designation is that sponsors may submit, and
the FDA may commence review of, portions of an application before the complete
application is submitted, provided that the FDA approves a schedule for
submission of the completed application. The sponsor of a fast track product
also may seek and obtain FDA approval based upon a determination that the
product has an effect on a clinical endpoint or on a surrogate endpoint that is
reasonably likely to predict clinical benefit. A product approved on this basis
is subject to rigorous postmarket compliance requirements, and the sponsor may
be required to conduct post-approval studies to validate and/or confirm the
endpoint. The FDA may withdraw approval of a fast track product if, for
example, the sponsor fails to conduct required post-approval studies or
disseminates false or misleading promotional materials. The Orphan Drug provisions of the FD&C Act provide incentives to drug and
biologics suppliers to develop and supply drugs for the treatment of rare
diseases, currently defined as diseases that affect fewer than 200,000
individuals in the United States or, for a disease that affects more than
200,000 individuals in the United States, where the sponsor does not
realistically anticipate its product becoming profitable. Under these
provisions, a supplier of a designated orphan product can seek tax benefits,
and the holder of the first FDA approval of a designated orphan product will be
granted a seven year period of marketing exclusivity for that product for the
orphan indication. The marketing exclusivity of an orphan drug would prevent
other sponsors from obtaining approval of the same drug for the same indication
without a showing of clinical superiority. It would not prevent other types of
drugs from being approved for the same use. We have been granted orphan
designation by the FDA for ZADAXIN for treatment of chronic active HBV,
DiGeorge Anomaly and hepatocellular carcinoma. In the European Union, incentives for suppliers to develop medicinal
products for the treatment of rare diseases are provided pursuant to the Orphan
Medicinal Products Regulation. Orphan medicinal products are those products
designed to diagnose, treat or prevent a condition which occurs so infrequently
that the cost of developing and bringing the product to the market would not be
recovered by the expected sale of the product. In the EU, the criterion for
designation is a prevalence of the relevant condition in no more than 5 per
10,000 of the population. The incentives include, amongst others, a reduction
in the fees payable in respect of the marketing authorization application,
protocol assistance for clinical trials in support of the application, and
marketing exclusivity once the authorization is granted. In the EU, marketing
exclusivity is granted to products with an orphan drug designation for a period
of 10 years during which the EU will not accept another application for a
marketing authorization for the same therapeutic indication in respect of a
similar medicinal product, unless the second applicant can show its product is
safer, more effective or otherwise clinically superior. A similar medicinal
product is defined as a medicinal product containing a similar active substance
as contained in the authorized orphan medicinal product. We have been granted orphan designation throughout the EU for ZADAXIN for
treatment of hepatocellular carcinoma. However, it should be noted that, as in
the United States, the granting of orphan drug status in the EU does not affect
the likelihood of success of obtaining regulatory approval or marketing
authorization for the relevant product in any way. Under the Drug Price Competition and Patent Term Restoration Act of 1984,
or DPCPTRA, a sponsor may be granted marketing exclusivity for a period of time
following FDA approval of certain drug applications, regardless of patent
status, if the drug is a new chemical entity or new clinical studies were used
to support the marketing application. This marketing exclusivity would prevent
a third party from obtaining FDA approval for a similar or identical drug
through an Abbreviated New Drug Application, or ANDA, which is the application
form typically used by suppliers seeking approval of a generic drug, or
505(b)(2) application. The DPCPTRA also allows a patent owner to extend the
term of the patent for a period equal to one-half the period of time elapsed
between the filing of an IND and the filing of the corresponding NDA plus the
period of time between the filing of the NDA and FDA approval with the maximum
patent extension term being five years. The Best Pharmaceuticals for Children
Act provides an additional six months of marketing exclusivity for new or
marketed drugs for certain pediatric testing conducted at the written request
of the FDA. We may seek the benefits of additional orphan, DPCPTRA, or fast track
provisions, with respect to ZADAXIN but we cannot assure that we will be able
to obtain any such benefits. We are subject to foreign regulations governing human clinical trials and
pharmaceutical sales. The requirements governing the conduct of clinical
trials, product licensing, pricing and reimbursement vary widely from country
to country. Whether or not FDA approval has been obtained, approval of a
product by the comparable regulatory authorities of foreign countries is
required prior to the commencement of marketing of our products in those
countries. The approval process varies from country to country and the time
required for approval may be longer or shorter than that required for FDA
approval. In general, foreign countries use one of three forms of regulatory
approval process. In one form, local clinical trials must be undertaken and the
data must be compiled and submitted for review and approval. In Japan, for
example, the process is time consuming and costly because certain pre-clinical
studies and clinical trials must be conducted in Japan. A second form of
approval process requires clinical trial submissions, but permits use of
foreign clinical trials and typically also requires some form of local trial as
well. A third form of approval process does 14




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not require local clinical trials, but rather contemplates submission of
an application including proof of approval by countries that have clinical
trial review procedures. Thus, a prior approval in one or more of the United
States, Japan, most European Union countries or Australia, among others, is
often sufficient for approval in countries using this third form of approval
process. The FDA regulates the export of drugs or bulk pharmaceuticals from the
United States. In general, a drug that has been approved for commercial sale in
the United States may be exported for commercial sale. An unapproved drug may
be exported to a listed country (Australia, Canada, Israel, Japan, New
Zealand, Switzerland, South Africa, and countries in the European Union and the
European Economic Area) for investigational purposes without FDA authorization
if exported in accordance with laws of the foreign country, and in accordance
with the export requirements. Export of drugs to an unlisted country for
clinical trial purposes continues to require FDA approval. An unapproved drug
can be exported to any country for commercial purposes without prior FDA
approval, provided that the drug (i) complies with the laws of that country,
and (ii) has valid marketing authorization or the equivalent from the
appropriate authority in a listed country. Export of drugs not approved in the
United States that do not have marketing authorization in a listed country
continue to require FDA export approval. We have obtained, where necessary, FDA
approval for all exports of ZADAXIN from the United States for clinical trial
purposes, and will seek to obtain FDA approval, where necessary, for any future
shipments from the United States to any unlisted country. We are also subject to various federal, state and local laws, regulations
and recommendations relating to safe working conditions, laboratory and
manufacturing practices, the experimental use of animals and the use and
disposal of hazardous or potentially hazardous substances, including
radioactive compounds and infectious disease agents, used in connection with
research work and preclinical and clinical trials and testing. The extent of
government regulation that might result from future legislation or
administrative action in these areas cannot be accurately predicted and could
prevent or delay regulatory approval of any of our products. The level of revenues and profitability of pharmaceutical companies may be
affected by the continuing efforts of governmental and third party payors to
contain or reduce the costs of health care through various means, including the
extent and availability of reimbursement. We are unable to predict when any
proposed health care reforms will be implemented, if ever, or the effect of the
implemented reforms on our business. Third-Party Reimbursement Our ability to successfully commercialize our products may depend in part
on the extent to which coverage and reimbursement to patients for our products
will be available from government health care programs, private health insurers
and other third-party payors or organizations. Significant uncertainty exists
as to the reimbursement status of new therapeutic products, such as ZADAXIN. In
most of the markets in which we sell or intend to sell ZADAXIN, reimbursement
for ZADAXIN under government or private health insurance programs is not yet
widely available, and in many of these countries government resources and per
capita income may be so low that our products will be prohibitively expensive.
In the United States, Europe and Japan, proposed health care reforms could
limit the amount of governmental or third-party reimbursement available for our
products. Various governments and third-party payors are trying to contain or
reduce the costs of health care through various means. We expect that there
will continue to be a number of legislative proposals to implement government
controls. Available Information We file electronically with the Securities and Exchange Commission (or
SEC) our annual reports on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934. The public may read or copy any materials we
file with the SEC at the SECs Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC. The address of that site is http://www.sec.gov. You may obtain a free copy of our annual reports on Form 10-K, quarterly
reports on Form 10-Q and current reports on Form 8-K and amendments to those
reports on the day of filing with the SEC on our website on the World Wide Web
at http:///www.sciclone.com, by contacting the Investor Relations Department at
our corporate offices by calling 800-724-2566 or by sending an e-mail message
to investorrelations@sciclone.com. 15




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Executive Officers of the Registrant As of February 20, 2004, the executive officers of the Company, who are
elected by and serve at the discretion of the Board of Directors, were as
follows: Name
    
    Age
    
    PositionDonald R. Sellers.
    
    
    59
    
    
    President, Chief Executive Officer, and Director,
SciClone Pharmaceuticals, Inc.; Managing
Director, SciClone Pharmaceuticals International
Ltd.Alfred R. Rudolph, M.D
    
    
    56
    
    
    Chief Operating OfficerRichard A. Waldron.
    
    
    50
    
    
    Chief Financial Officer and SecretaryHans P. Schmid.
    
    
    52
    
    
    Vice President, Finance, Administration & Business
Development for SciClone Pharmaceuticals
International Ltd.
 Donald R. Sellershas served as our President and one of our directors
since January 1996 and our Chief Executive Officer since March 1996. From 1993
to present, he has also served as Managing Director of SciClone Pharmaceuticals
International Ltd. Mr. Sellers has nearly 30 years of experience in the global
pharmaceutical industry, working with SciClone, Pfizer, Revlon Healthcare Group
and Sterling Drug International. Mr. Sellers spent five years in U.S. Military
Intelligence serving with Special Forces and as a Counter-Intelligence Special
Agent. He has an A.B. degree from Lafayette College and a Master of
International Management degree with honors from the American Graduate School
of International Management. Alfred R. Rudolph, M.D., has served as our Chief Operating Officer since
1998. Dr. Rudolph has over 30 years of experience in the biopharmaceutical
industry. Since joining us in April 1997, Dr. Rudolph has been responsible for
the clinical, research, regulatory, manufacturing, and quality assurance
functions of our company. Before joining us, Dr. Rudolph was President and
Chief Operating Officer of Neptune Pharmaceuticals, Inc., a marine-based
natural product screening company. Previously, Dr. Rudolph was Senior Vice
President of T Cell Sciences, Inc., Director of Clinical Operations at Cetus
Corporation, and Clinical Assistant Professor of Medicine at University of
California, San Francisco. He began his pharmaceutical career with Bristol
Myers, where he worked in cancer drug development. Dr. Rudolph earned a B.S. in
Electrical Engineering from the University of Rochester, and completed his
medical training in Hemotology-Oncology at Syracuse University. Richard A. Waldronhas served as our Chief Financial Officer since 2001.
Mr. Waldron has over 20 years of experience in the finance and management of
biotechnology companies. Prior to joining us in March 2001, he was Vice
President and Chief Financial Officer from June 1999 to August 2000 for
Genelabs Technologies, Inc. and from July 1995 through March 1999, he was Vice
President and Chief Financial Officer of GeneMedicine, Inc. From 1990 to 1995,
he was a managing director and the head of finance for technology-based
companies at Rauscher Pierce Refsnes, Inc., an investment banking firm. From
1985 to 1990, he was a senior vice president responsible for health care
investment banking at Cowen & Company. Mr. Waldron received his M.B.A. degree
with honors from Harvard University and his A.B. degree magna cum laude in
Economics from Princeton University. Hans P. Schmidhas served as Vice President, Finance, Administration and
Business Development for SciClone Pharmaceuticals International Ltd. since
2001. Mr. Schmid also has line responsibility for international operations
outside the Greater China region. He has 25 years of financial and
pharmaceutical experience in the U.S. and international markets. Prior to
joining SciClone, Mr. Schmid was Chief Financial Officer of Questcor
Pharmaceuticals, Inc. and before that Senior Vice President, International
Business Development of Oread, Inc., a contract pharmaceutical company. He also
worked at Syntex Corporation as Vice President of Finance and Administration
for Pharmaceutical Operations Asia/Pacific region, at F. Hoffmann-LaRoche as
Senior Vice President, Finance and Head of Administrative Services for Roche
Bioscience and held financial and operational positions with Itel Corporation
in Germany, Japan, England and the United States. He received his B.A. degree
from the Commercial Trade School, Lucerne, Switzerland, and has studied
International Business Management and Finance at San Francisco State
University. There are no family relationships among any of the directors or executive
officers of the Company. 16




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##### Table of Contents



Item 2.Properties We currently lease approximately 15,368 square feet of office space at our
headquarters in San Mateo, California and limited office space in Beijing, Hong
Kong, Rome, Sao Paulo, Shanghai, Singapore, and Tokyo. We believe that our
existing facilities will be adequate for our current needs and that additional
space will be available as needed. 
 Item 3.Legal Proceedings None 
 Item 4.Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2003. 
 PART II 
 Item 5.Market for the Registrants Common Equity and Related Stockholder Matters Our Common Stock trades on The NASDAQ National Market under the symbol
SCLN. The following table sets forth the high and low sale prices per share for
the quarterly periods indicated, as reported by The NASDAQ National Market. The
quotations shown represent inter-dealer prices without adjustment for retail
markups, markdowns, or commissions, and may not necessarily reflect actual
transactions. Price RangeCommon StockHigh
    
    Low20034th quarter
    
    $
    9.01
    
    
    $
    6.413rd quarter
    
    
    9.76
    
    
    
    6.362nd quarter
    
    
    9.10
    
    
    
    5.151st quarter
    
    
    6.12
    
    
    
    3.1020024th quarter
    
    $
    4.35
    
    
    $
    2.503rd quarter
    
    
    3.27
    
    
    
    1.982nd quarter
    
    
    4.98
    
    
    
    1.971st quarter
    
    
    4.85
    
    
    
    2.13
 Recent Sales of Unregistered Securities On January 21, 2003, we completed a direct placement to affiliates of
Sigma-Tau pursuant to the exemption from registration provided under section
4(2) of the Securities Act of 1933, as amended. The affiliates purchased
504,938 shares of SciClones common stock at $3.5648 per share, resulting in an
aggregate purchase of $1,800,003. No underwriters were involved in this
transaction. The shares issued were restricted securities, and Sigma Tau and
its affiliates were not permitted to sell any of the shares purchased in this
private placement until January 24, 2004. Prior to this transaction, 400,000
warrants held by Sigma-Tau to purchase shares of SciClones common stock were
cancelled. Stockholders As of February 20, 2004, there were approximately 400 holders of record of
our common stock and 44,583,412 shares of common stock issued and outstanding. Dividends We have not paid any dividends on our common stock during the fiscal years
ended December 31, 2003, 2002, and 2001 and currently intend to retain any
future earnings for use in our business. 17




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##### Table of Contents



Item 6.Selected Consolidated Financial Data This section presents selected historical financial data for each of the
last five fiscal years and is qualified by reference to and should be read in
conjunction with the consolidated financial statements and notes thereto
included elsewhere in this Annual Report on Form 10-K. Year Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999Statement of Operations data:Product sales
    
    $
    31,732,000
    
    
    $
    17,101,000
    
    
    $
    13,831,000
    
    
    $
    15,357,000
    
    
    $
    9,091,000Contract/grant revenue
    
    
    806,000
    
    
    
    671,000
    
    
    
    
    
    
    
    
    
    
    
    307,000Total revenues
    
    
    32,538,000
    
    
    
    17,772,000
    
    
    
    13,831,000
    
    
    
    15,357,000
    
    
    
    9,398,000Cost of product sales
    
    
    5,636,000
    
    
    
    3,487,000
    
    
    
    2,742,000
    
    
    
    3,113,000
    
    
    
    1,761,000Gross margin
    
    
    26,902,000
    
    
    
    14,285,000
    
    
    
    11,089,000
    
    
    
    12,244,000
    
    
    
    7,637,000Operating expenses:Research and development
    
    
    18,949,000
    
    
    
    11,647,000
    
    
    
    8,561,000
    
    
    
    4,182,000
    
    
    
    4,604,000Sales and marketing
    
    
    9,018,000
    
    
    
    8,724,000
    
    
    
    8,764,000
    
    
    
    7,720,000
    
    
    
    5,503,000General and administrative
    
    
    4,134,000
    
    
    
    3,902,000
    
    
    
    3,897,000
    
    
    
    3,538,000
    
    
    
    3,386,000Total operating expenses
    
    
    32,101,000
    
    
    
    24,273,000
    
    
    
    21,222,000
    
    
    
    15,440,000
    
    
    
    13,493,000Loss from operations
    
    
    (5,199,000
    )
    
    
    (9,988,000
    )
    
    
    (10,133,000
    )
    
    
    (3,196,000
    )
    
    
    (5,856,000
    )Income from payment on note
receivable from former officer
    
    
    
    
    
    
    
    
    
    
    3,497,000
    
    
    
    400,000
    
    
    
    20,000Interest and investment income
    
    
    266,000
    
    
    
    323,000
    
    
    
    751,000
    
    
    
    1,066,000
    
    
    
    157,000Interest expense
    
    
    (361,000
    )
    
    
    (361,000
    )
    
    
    (334,000
    )
    
    
    (36,000
    )
    
    
    Other income (expense), net
    
    
    19,000
    
    
    
    (11,000
    )
    
    
    (13,000
    )
    
    
    49,000
    
    
    
    212,000Net loss
    
    $
    (5,275,000
    )
    
    $
    (10,037,000
    )
    
    $
    (6,232,000
    )
    
    $
    (1,717,000
    )
    
    $
    (5,467,000
    )Basic and diluted net loss per share
    
    $
    (0.13
    )
    
    $
    (0.29
    )
    
    $
    (0.19
    )
    
    $
    (0.06
    )
    
    $
    (0.26
    )Weighted average shares used in
computing basic and diluted
net loss per share
    
    
    39,568,199
    
    
    
    35,002,003
    
    
    
    32,356,287
    
    
    
    29,904,924
    
    
    
    21,162,936
 December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999Balance Sheet data:Cash, cash equivalents and
investments
    
    $
    62,975,000
    
    
    $
    21,150,000
    
    
    $
    16,468,000
    
    
    $
    22,497,000
    
    
    $
    3,621,000Working capital
    
    
    72,950,000
    
    
    
    29,116,000
    
    
    
    26,930,000
    
    
    
    30,281,000
    
    
    
    7,091,000Total assets
    
    
    83,822,000
    
    
    
    37,111,000
    
    
    
    32,096,000
    
    
    
    36,167,000
    
    
    
    13,124,000Total stockholders equity
    
    
    68,250,000
    
    
    
    23,354,000
    
    
    
    22,774,000
    
    
    
    28,077,000
    
    
    
    9,301,000Convertible notes payable
    
    
    5,600,000
    
    
    
    5,600,000
    
    
    
    5,600,000
    
    
    
    4,000,000
    
    
    
    
 18




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Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations This Managements Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the Selected
Consolidated Financial Data and our financial statements and related notes
thereto included elsewhere in this Annual Report on Form 10-K. This
Managements Discussion and Analysis of Financial Condition and Results of
Operations and other parts of this Annual Report on Form 10-K contain
forward-looking statements which involve risks and uncertainties. See Note
Regarding Forward-Looking Statements and Risk Factors contained in this
Annual Report on Form 10-K. Overview Our current primary business objective is to obtain regulatory approval
for and commercialize ZADAXIN in the major pharmaceutical markets of the United
States, Europe and Japan. Our long term business objective is to be a leading
biopharmaceutical company engaged in the development and commercialization of
therapeutics to treat life-threatening diseases. During the periods encompassed by this Annual Report on Form 10-K, we have
devoted substantially all of our resources to our ZADAXIN clinical trials and
our ZADAXIN commercialization activities. Our primary focus has been the
clinical development of ZADAXIN as a part of a new combination therapy for the
treatment of hepatitis C. We believe that the worldwide market for HCV
therapies was approximately $3 billion in 2003 and could exceed $8 billion in
2012 and that the United States, Europe and Japan account for essentially all
of this market opportunity. Currently, there are only two approved and marketed
therapies for hepatitis C, interferon alpha (predominantly in pegylated forms)
and ribavirin in combination with interferon alpha. Two large pharmaceutical
companies, Schering-Plough and Roche, each market their brands of pegylated
interferon alpha and ribavirin and dominate the hepatitis C therapeutic market.
Our strategy is to develop ZADAXIN to be used in combination with and to
improve the efficacy of current therapy, and we are currently conducting in the
United States two phase 3 hepatitis C clinical trials of ZADAXIN in combination
with pegylated interferon. We intend to complete these trials by the end of
2005 and, if successful, file a NDA in mid-2006. We are also developing ZADAXIN in Japan as a monotherapy for the treatment
of hepatitis B. We completed a phase 3 clinical trial there in 2003 and are
targeting to file a NDA in Japan by the end of 2004. We estimate the worldwide
market for HBV therapeutics was approximately $320 million in 2003 and is
expected to increase to over $2 billion in 2012. The largest market for
hepatitis B therapies is Asia where we have regulatory approval in several
countries. Our commercialization and marketing activities to date have been
concentrated on China. We believe that our ability to significantly expand the
ZADAXIN sales opportunities in the developing countries in the future will
depend on our securing regulatory approval in the United States, Europe or
Japan. We manufacture ZADAXIN for sale, and for our clinical trials, through
third party contract manufacturers, and we conduct our research and development
efforts principally through arrangements with clinical research sites, contract
research organizations and universities. From commencement of operations through December 31, 2003, we have an
accumulated deficit of approximately $138,000,000. At least over the next two
years, we expect net losses to increase due to increased operating expenses as
we expand our research and development, clinical testing and sales and
marketing capabilities. Our ability to achieve and sustain operating
profitability is primarily dependent on the execution and successful completion
of ZADAXIN clinical trials and securing regulatory approvals for ZADAXIN in the
United States, Europe, and Japan, and, if approved in those countries, the
successful commercialization and marketing of ZADAXIN. In addition, other
factors may also impact our ability to achieve and sustain operating
profitability, including the pricing of ZADAXIN and its manufacturing and
marketing costs, the cost of long-term product development and
commercialization programs, the timing and costs of acquiring rights to
additional drugs, our ability to fund our operations and the entrance into and
extension of agreements for product development and commercialization, where
appropriate. We expect net sales for 2004 to be lower than net sales for 2003, as we
are not anticipating any significant new source of demand for ZADAXIN, such as
the SARS epidemic in China during the second quarter of 2003. We expect
quarterly net sales for 2004 to be similar to those reported for the third and
fourth quarters of 2003. Expected research and development expenses for 2004
are higher than research and development expenses for 2003 due to increased
expenses for our phase 3 hepatitis C clinical trials in the United States as
well as for the development of SCV-07. Expected net loss and net loss per
share for 2004 are higher than net loss and net loss per share for 2003 based
on our lower net sales estimates and higher research and development expenses.
Cash, cash equivalents and short-term investments at December 31, 2004 are
expected to be lower than at December 31, 2003 primarily due to the expected
net loss from operations. 19




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Our operating results may fluctuate from quarter to quarter and these
fluctuations may be substantial as a result of, among other factors, the
number, timing, costs and results of preclinical and clinical trials of our
products, market acceptance of ZADAXIN and the timing of orders for ZADAXIN
from international markets, particularly China, the regulatory approval
process, the timing of FDA or international regulatory approvals, and the
acquisition of additional product rights and the funding, if any, provided as a
result of corporate partnering arrangements. Critical Accounting Policies General We have identified the policies below as critical to our business
operations and the understanding of our results of operations. The impact and
any associated risks related to these policies on our business operations is
discussed throughout Managements Discussion and Analysis of Financial
Condition and Results of Operations where such policies affect our reported
and expected financial results. For a detailed discussion on the application of
these and other accounting policies, see Note 1 in the Notes to the
Consolidated Financial Statements in Item 8 of this Annual Report on Form
10-K. The Consolidated Financial Statements have been prepared in accordance
with accounting principles generally accepted in the United Sates, which
requires us to make estimates and assumptions that affect the reported amount
of assets and liabilities, disclosure of contingent assets and liabilities at
the date of our financial statements, and the reported amounts of revenue and
expenses during the reporting period. On an on-going basis, we evaluate the
relevance of our estimates. We base our estimates on historical experience and
on various other market specific assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. There can be no assurance that actual
results will not differ from those estimates. Revenue Recognition We recognize revenue from product sales at the time of shipment. There are
no significant customer acceptance requirements or post-shipment obligations on
our part. 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, we 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 for which there is no
continuing involvement by us, are recognized on the earlier of when the
payments are received or when collection is assured. We exercise judgment in
determining the period over which our performance obligations have been
fulfilled which can have an impact on the timing and amount of revenue that is
recognized in a particular reporting period. 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. We exercise judgment in our determination of the achievement of
milestones which can have an impact on the timing and amount of revenue
recognized in a particular reporting period. Amounts invoiced relating to arrangements where revenue cannot be
recognized are reflected on our balance sheet as deferred revenue and
recognized as the applicable revenue recognition criteria are satisfied. Accounts Receivable We are required to estimate the collectibility of our trade receivables.
We maintain reserves for credit losses, and such losses have been within our
expectations. We recognize reserves for bad debts ranging from 25% to 100% of
past due accounts receivable based on the length of time the receivables are
past due and our collectibility experience. A considerable amount of judgment
is required in assessing the ultimate realization of these receivables
including, but not limited to, an analysis of the historical payment patterns
of our customers, individual customer circumstances and their geographic region
including a review of the local economic environment. Our ability to collect
outstanding receivables from our customers is critical to our operating
performance and cash flows. We maintain allowances for doubtful accounts for
estimated losses resulting from the inability of our customers to make required
payments. If the financial condition of our customers or the economic
environment in which they operate were to deteriorate, resulting in an 20




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impairment of their ability to make payments, additional allowances may be
required which would increase our general and administrative expenses and
increase our reported net loss. Conversely, if actual credit losses are
significantly less than our reserve, this would decrease our general and
administrative expenses and decrease our reported net loss. Inventories Our inventories are stated at the lower of cost or realizable market
value. In assessing the ultimate realization of inventories, we are required to
make judgments as to future demand requirements and compare that with the
current inventory levels. It is possible that changes in inventory reserves may
be required in the future due to a change in market conditions. We have begun
production with a new contract manufacturer and are currently in the process of
qualifying the product to permit its importation into China. In the fourth
quarter of 2003 we began building inventory levels to ensure an uninterrupted
supply of product for our distributors in China and elsewhere. We expect these
inventory levels to decrease during the second half of 2004. If we are unable
to qualify in a timely fashion the product produced by the new contract
manufacturer, our inventory reserves may be insufficient and could result in an
increase in inventory reserves and in net loss. Impairment of Intangible Assets At December 31, 2003, we had net intangible assets of $612,000 related to
ZADAXIN product rights and had never recorded any impairment losses related to
intangible assets. In assessing the recoverability of our intangible assets we
must make assumptions regarding estimated future cash flows and other factors
to determine the fair value of the respective assets. If these estimates or
their related assumptions change in the future, we may be required to record
impairment charges for these assets. Research and Development Expenses Our research and development expenses are principally incurred for our
phase 3 clinical trials in the United States. Research and development
expenses are charged to operations as incurred. Our cost accruals for clinical
trials are based on estimates of the services received and efforts expended
pursuant to contracts with numerous institutions that conduct the clinical
trials on our behalf. The financial terms of these agreements are subject to
negotiation and variation from contract to contract and may result in uneven
payment flows. Payments under the contracts depend on factors such as the
achievement of certain events, the successful enrollment of patients, and the
completion of portions of the clinical trial or similar conditions. The
objective of our accrual policy is to match the recording of expenses in our
financial statements to the actual services received and efforts expended.
Expenses related to grants to the institutions are accrued based on the level
of patient enrollment and activity according to the protocol. In general, these
expenses will be higher for the initial and final months of a patients
scheduled 18 months of treatment and observation. Expenses relating to the
clinical research organization managing the trials and laboratory and other
direct expenses are recognized in the period they are incurred and the services
performed. We monitor patient enrollment levels and related activity to the
extent possible and adjust our estimates accordingly; however, if management
has underestimated activity levels associated with various studies at a given
point in time, we could underestimate our actual research and development
expenses, requiring the recording of additional expenses and an increase in net
loss. Results of Operations Product sales were $31,732,000, $17,101,000 and $13,831,000 for the years
ended December 31, 2003, 2002 and 2001, respectively, and all were derived from
sales of ZADAXIN. These increases were attributable to higher volume of
product sold as prices have remained stable. Sales to customers in China
accounted for approximately 88%, 88% and 89% of this revenue for the years
ended December 31, 2003, 2002 and 2001, respectively. Of the total increase in
sales of $14,631,000 from 2002 to 2003, approximately $11,000,000 was from an
unanticipated temporary increase in demand for ZADAXIN from hospitals in China
at the time of the SARS outbreak during the second quarter of 2003. For each of the years ended December 31, 2001 through 2003, sales to
between four and six importing agents in China accounted for approximately 88%
of our product sales. The single largest customer accounted for 52%, 41% and
47% of sales for the years ended December 31, 2003, 2002 and 2001,
respectively. However, the importing agent who was the single largest customer
varied each year. As of December 31, 2003, approximately $9,112,000 or, 89% of
our accounts receivable were attributable to five customers in China. We
perform on-going credit evaluations of our customers financial condition, and
generally do not require collateral from our customers. 21




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Contract revenue was $806,000, $671,000, and $0 for the years ended
December 31, 2003, 2002 and 2001, respectively. The contract revenue we
recognized was in connection with the $2,685,000 payment we received from
Sigma-Tau in January 2002. This revenue is 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 requirements under our contract with Sigma-Tau. Gross margin was 83% in 2003, and 80% in both 2002 and 2001. The increase
in gross margin in 2003 was largely attributable to product-related fixed costs
being spread over the significantly larger volume of units sold. We expect
cost of product sales and hence gross margin to vary from year to year,
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 expenses were $18,949,000, $11,647,000 and
$8,561,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
The increase in each year was to support our ZADAXIN phase 3 clinical trials,
primarily in the United States and to a lesser extent in Japan. In 2003, 2002
and 2001, research and development (R&D) expenses represented approximately
59%, 48% and 40%, respectively, of our total costs and expenses. The major
components of R&D expenses consist of clinical studies performed by clinical
trial institutions and contract research organizations, related materials and
supplies, preclinical work, pharmaceutical development, personnel costs,
including salaries and benefits, third party research funding, and overhead
allocations consisting of various support and facilities related costs. Our
research and development activities are also separated into three main
categories: research, clinical development and pharmaceutical development.
Research costs typically consist of preclinical and toxicology work. Clinical
development costs include Phase 1, 2, and 3 clinical trials as well as expanded
clinical access programs. Pharmaceutical development costs consist of product
formulation and chemical analysis. During 2003, we recorded approximately
$2,100,000 on research, $13,200,000 on clinical development, and $2,300,000 on
pharmaceutical development activities. This compares to expenses in 2002 of
approximately $2,300,000 on research, $8,300,000 on clinical development, and
$1,100,000 on pharmaceutical development activities and expenses in 2001 of
approximately $2,800,000 on research, $5,000,000 on clinical development, and
$800,000 on pharmaceutical development activities. 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. An expansion or significant extension of our clinical
development programs may require us to seek additional capital resources. Due
to the uncertain nature of the clinical trial process, and enrollment rates in
particular, it is not possible to determine the timing of completion or total
cost expected to be incurred for each trial. In general, we expect research
and development expenses to increase significantly at least over the next two
years and 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 expenses were $9,018,000, $8,724,000 and $8,764,000
for the years ended December 31, 2003, 2002 and 2001, respectively. The
year-to-year increases from 2001 to 2003 were related to increased payroll
expenses and expenses for advertising and conferences associated with the
expansion of our markets for ZADAXIN; however, we expect sales and marketing
expenses to increase in the next several quarters and years as we expand our
commercialization and marketing efforts. General and administrative expenses were $4,134,000, $3,902,000 and
$3,897,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
The year-to-year increases from 2001 to 2003 were attributable to greater
general and administrative activities to support an increased level of research
and development on our late-stage clinical programs. In the near term, we
expect general and administrative expenses to vary quarter to quarter as we
increase our general and administrative activities and resources to support
increased expenditures on preclinical and clinical trials and testing, and
regulatory, pre-commercialization and marketing activities. Interest and investment income was approximately $266,000, $323,000 and
$751,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
The decrease over the years was primarily due to lower interest rates.
Interest expense relating to $5,600,000 of convertible notes payable was
$361,000 for the year ended December 31, 2003. Net loss for the years ended December 31, 2003, 2002 and 2001 was
$5,275,000, $10,037,000 and $6,232,000, respectively. Net loss decreased in
2003 due to higher net sales and gross margin. Net loss in 2002 was higher
than in 2001 due to an increase in research and development expenses and to a
gain in 2001 of $3,497,000 from the full repayment on a note receivable from a
former officer. Net loss per share for the years ended December 31, 2003, 2002
and 2001 was $0.13, $0.29 and $0.19, respectively. Weighted average shares
outstanding for the year ending December 31, 2003, 2002 and 2001 were
39,568,199, 35,002,003 and 32,356,287, respectively. The increase in the
shares outstanding is primarily due to financing activities in 2003 and 2002. 22




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Liquidity and Capital Resources At December 31, 2003, 2002 and 2001, we had $62,975,000, $21,150,000 and
$16,468,000, respectively, in cash, cash equivalents and short-term
investments. In each of these years, the principal factors affecting these
balances were the net loss and cash provided by financing activities. We
currently estimate cash, cash equivalents and short-term investments at
December 31, 2004 will be lower than the balance at December 31, 2003. The
expected decrease in this balance is attributable to an expected net loss and
no plan for a financing for the year. The short-term investments consist
primarily of highly liquid marketable securities. We have two letters of credit
each secured by a certificate of deposit. At December 31, 2003, the letters of
credit totaled $695,000, one for $633,000 under our lease agreement, the other
for $62,000 to facilitate our value added tax filings in Europe. Net cash used in operating activities totaled $8,055,000, $5,890,000 and
$12,042,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Net cash used in operating activities for the year ended December 31, 2003 was
more than the net loss primarily due to a $2,347,000 increase in inventory
levels expected to provide an uninterrupted supply of ZADAXIN as we began
production with a new contract manufacturer. Net cash used in operating
activities for the year ended December 31, 2002 was less than the net loss
primarily due to the receipt of a payment from Sigma-Tau for a clinical trial
collaboration which increased deferred revenue balances by $2,014,000, and due
to increases in accounts payable of $1,576,000 partially offset by increases in
prepaid expenses and other assets of $967,000 mostly associated with our phase
3 clinical trials in the United States. Net cash used in operating activities
for the year ended December 31, 2001 was $12,042,000, mainly attributable to a
net loss from operations of $6,232,000 and an increase in inventory of
$2,039,000. Cash provided by investing activities is primarily the net result of
purchases and sales of short-term investments to provide working capital for
operations. We purchased $303,000 of property and equipment during the year
ended December 31, 2003. Net cash provided by financing activities totaled $50,074,000, $10,577,000
and $5,995,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. Net cash provided by financing activities for the year ended
December 31, 2003 consisted of approximately $44,426,000 from a follow-on
public offering of common stock, approximately $2,536,000 from the exercise of
outstanding warrants to purchase common stock by institutional and accredited
investors, approximately $1,800,000 from the issuance of common stock to
Sigma-Tau, approximately $1,050,000 related to exercises of outstanding options
under our employee stock option plans and $262,000 from the issuance of common
stock under our employee stock purchase plan. Net cash provided by financing
activities for the year ended December 31, 2002 consisted of approximately
$9,914,000 from a direct offering of common stock to institutional investors,
approximately $514,000 related to exercises of outstanding options under our
employee stock option plans and $149,000 from the issuance of common stock
under our employee stock purchase plan. Net cash provided by financing
activities for the year ended December 31, 2001 consisted of $1,600,000 in
proceeds from the issuance of a convertible note, $544,000 in net proceeds from
the issuance of common stock, $354,000 from granting an investor the right to
purchase approximately $2,400,000 of senior unsecured convertible notes, and
$3,497,000 from the payment on a note receivable from a former officer. The following table summarizes our contractual obligations and other
commitments as of December 31, 2003. Payments Due by PeriodContractual
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    MoreObligations
    
    Total
    
    Less than 1 year
    
    1-3 years
    
    3-5 years
    
    than 5 yearsConvertible notes payable (1)
    
    $
    6,296,000
    
    
    $
    336,000
    
    
    $
    5,960,000
    
    
    $
    
    
    
    $
    Operating leases (2)
    
    
    4,958,000
    
    
    
    1,383,000
    
    
    
    2,702,000
    
    
    
    873,000
    
    
    
    Purchase obligations (3)
    
    
    5,270,000
    
    
    
    3,266,000
    
    
    
    1,854,000
    
    
    
    130,000
    
    
    
    20,000
    (4)Other long-term liabilities (5)
    
    
    1,200,000
    
    
    
    300,000
    
    
    
    900,000
    
    
    
    
    
    
    
    Total
    
    $
    17,724,000
    
    
    $
    5,285,000
    
    
    $
    11,416,000
    
    
    $
    1,003,000
    
    
    $
    20,000
  (1)
    
    $4,000,000 of these convertible notes mature in
December 2005 and $1,600,000 mature in March 2006. See note 7 of the consolidated
financial statements. Included in the amounts above is $696,000 for
interest payments.(2)
    
    These are future minimum rental commitments for office space leased
under non-cancelable operating lease arrangements.(3)
    
    This includes $20,000 per year in minimum royalty payments to the
U.S. Army, $45,000 per year in minimum royalty payments to the NIH,
approximately $1,627,000 in minimum purchase requirement from a
contract manufacturer, approximately $3,298,000 in research and
development fees payable to the contract research organization under
our agreement for the U.S. phase 3 hepatitis C clinical trials. 23




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(4)
    
    This represents $20,000 per year in minimum royalty payments to
the U.S. Army.(5)
    
    These are required non-cancelable prepaid royalties to be paid to
Wayne State University. See note 5 of the consolidated
financial statements. We intend to give priority use of our financial resources to ZADAXIN
clinical programs in the United States. We believe our existing capital
resources and funds from product sales are sufficient to complete our current
U.S. phase 3 clinical trials and, if the trials are successful and we receive
FDA approval, to begin commercialization of ZADAXIN in the United States.
However, we cannot assure you that such funds will be sufficient, or that sales
of ZADAXIN, if approved in the United States, will result in profitable
operations. In the event we need to raise additional financing, the
unavailability or the inopportune timing of any financing could prevent or
delay our long-term product development and commercialization programs, either
of 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. There are no officers or directors that were involved in related party
transactions in 2003. Off-Balance Sheet Arrangements There are no off-balance sheet arrangements in 2003, 2002 or 2001. Income Taxes At December 31, 2003, we had net operating loss carryforwards for federal
income tax purposes of approximately $86,000,000 which expire in the years 2006
through 2023. The difference between the cumulative losses for financial
reporting purposes and federal income tax purposes is primarily attributable to
losses incurred by our foreign subsidiaries. At December 31, 2003, we had
federal tax credit carryforwards of approximately $4,900,000 which expire in
the years 2009 through 2023. Because of the change in ownership provisions of the Internal Revenue
Code, a portion of our net operating loss carryforwards and tax credit
carryforwards may be subject to an annual limitation regarding their
utilization against taxable income in future periods. As a result of the annual
limitation, a portion of these carryforwards may expire before ultimately
becoming available to reduce future income tax liabilities. Risk Factors You should carefully consider the risks described below, in addition to
the other information in this report onForm 10-K, 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. If we are unable to commercialize ZADAXIN in various markets for multiple
indications, particularly in the United States for the treatment of HCV, our
business will be harmed. 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, Europe and Japan. We are also
dependent on our ability to increase ZADAXIN sales in existing markets and
launch ZADAXIN in new 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 in the United States. We cannot assure you
that we will achieve significant levels of sales or that we will receive
approval for ZADAXIN for the treatment of HCV in the United States or for the
treatment of HCV or other indications in other countries. If we are unable to
do so, our business will be harmed. 24




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If we do not obtain regulatory approval for ZADAXIN for the intended
indications that we are evaluating, our revenues will be limited and we will
not become profitable. Our ability to execute on our business strategy requires that we obtain
regulatory approval for the use of ZADAXIN, particularly for the treatment of
HCV in the United States, both HBV and HCV in Japan and both HCV and malignant
melanoma in Europe. If our current phase 3 trials in the United States and
current and future trials in Europe yield favorable results, we intend to
submit applications for marketing approval of ZADAXIN for the treatment of HCV
in the United States and through our partner, Sigma-Tau, for the treatment of
HCV and malignant melanoma in Europe. Based on the results of our recently
completed phase 3 trial in Japan, we intend to submit a regulatory filing for
the treatment of HBV in Japan. The regulatory approval process in the United
States, Europe and Japan is demanding and typically requires 12 months or more
in the United States and 18 months or more in Europe and Japan from the date of
submission of a New Drug Application. We have committed significant resources,
including capital and time, to develop ZADAXIN, particularly for HCV in the
United States, 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. 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 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 is also
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, Europe or Japan. 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. 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 our products in countries
where we currently do not have such rights, our revenues will be limited. 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. If the results of our clinical trials are not favorable, we will be unable to
obtain regulatory approval for the intended indications we are evaluating. 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 drug products are safe and efficacious under regulatory guidelines to
qualify for commercial sale. We cannot assure you, nor can you rely on our
previous clinical trial results to predict, that our ongoing or future clinical
trials will yield favorable results. Adverse or inconclusive clinical results
would prevent us from filing for regulatory approval of ZADAXIN for the
indications that we are evaluating, and our current programs in those areas
would fail. In the past, Alpha 1 Biomedical, from which we acquired certain
rights to thymosin alpha 1, conducted a phase 3 clinical trial of thymosin
alpha 1 as a therapy for HBV that did not produce statistically significant
results and Alpha 1 Biomedical did not submit a new drug application to the
FDA. We are currently conducting phase 3 clinical trials based on the use of
ZADAXIN in combination with pegylated interferon alpha for the treatment of HCV
patients who did not previously respond to treatment. We cannot assure you that
these phase 3 clinical trials will yield sufficient or adequate data to
demonstrate appropriate safety and efficacy under FDA guidelines. Any failure
to obtain sufficient or adequate data could delay or prevent us from securing
FDA approval. Our two phase 3 HCV clinical trials in the United States have been
designed to show that the combination of ZADAXIN and pegylated interferon alpha
adds a significant clinical benefit when compared to the use of pegylated
interferon alpha alone in non- 25




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responders. We cannot assure you that the results of this combination
therapy will yield the favorable results we expect, or that the independent use
of pegylated interferon alpha will not perform better than anticipated, which
could reduce the chances that a new drug application, or NDA, will be approved.
If the combination therapy of ZADAXIN and pegylated interferon alpha causes
significant adverse side effects beyond those caused by pegylated interferon
alpha alone, our clinical trials could be delayed, patients may drop out at a
greater than anticipated rate, we may be forced to halt the trials or the FDA
may reject an NDA due to safety issues. If any of the foregoing occurs, our
efforts to market and sell ZADAXIN in the United States will be significantly
impaired, our business will suffer and the price of our stock may decline. Our phase 3 HBV clinical trial in Japan was designed to demonstrate a
clinical benefit measured by an analysis of a combination of safety and
efficacy data points. We cannot assure that the results of this study will
warrant favorable consideration by the Japanese Ministry of Health and Welfare
or result in a marketing registration of ZADAXIN. If additional studies or
other data are required for regulatory consideration, our efforts to market and
sell ZADAXIN in Japan will be significantly impaired, our business will suffer
and the price of our stock may decline. If we experience delays in patient enrollment in our clinical trials, we may
not be able to obtain regulatory approval in accordance with our anticipated
timeline. Each of our two current phase 3 HCV clinical trials in the United States
are designed to enroll 500 patients, one trial treating patients with no liver
damage and the other trial treating patients with mild cirrhosis of the liver.
The 500 patient enrollment is complete in the first trial, however if we are
unable to enroll a sufficient number of patients in the second trial, if such
enrollment is delayed or if patient drop out rates in either trial are higher
than anticipated, our ability to proceed with our clinical trials and prepare
an NDA would be adversely affected. In particular, we are experiencing
competition for patients with mild cirrhosis of the liver, from trials
sponsored by other commercial drug developers and from a trial sponsored by the
National Institutes of Health. Competition for the enrollment of similar
patients in other clinical trials or other delays in enrollment may prevent us
from enrolling patients quickly enough to meet our current timing expectations
for completing our phase 3 trials, which would delay the preparation of an NDA.
If we are not able to fully enroll patients for both of these clinical trials
or patient drop out rates are higher than anticipated, it could reduce the
chances that our NDA will be approved. 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 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. Due to the outbreak of SARS in China, sales of ZADAXIN in the second quarter of
2003 were significantly higher than expected and are not indicative of future
sales. Our sales for the quarter ended June 30, 2003 were more than 200% greater
than sales for any quarter in our history as a result of a previously
unanticipated increase in sales of ZADAXIN to hospitals in China. This increase
was related to the use of immune system enhancers, including ZADAXIN, in
connection with the treatment of severe acute respiratory syndrome, or SARS. In
future quarters, sales of ZADAXIN for the treatment of SARS could be affected
by changes in treatment in China, changes in the rate of infection and the
emergence of evidence as to the effectiveness or ineffectiveness of ZADAXIN or
of other potential treatments for SARS. As a result of the containment of the SARS epidemic, we expect sales in
future quarters to be more consistent with sales patterns of the third and
fourth quarters, both of which have significantly lower sales results than
those of the second quarter in 2003. We could experience fluctuations in sales
in future quarters as a result of similar factors. 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. It is not
possible to predict at this time if SARS will re-emerge, like influenza, as a
seasonal public health problem and what effect, if any, this would have on
future sales of ZADAXIN. To the extent that ZADAXIN is purchased in connection
with future outbreaks of SARS or other 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. 26




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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 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 financial condition will be
harmed. Substantially all of our ZADAXIN sales are to customers in China. 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. Several local
companies have introduced lower priced locally manufactured generic competitive
products. If these sales continue, there could be a negative impact on the
price and the volume of ZADAXIN sold in China and this would harm our business. In addition, 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 and unexpected changes in regulatory requirements.
In addition, we experience other issues with managing foreign sales operations
including long payment cycles, 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. We do not have product sales in the United States with which to offset any
decrease in our revenue from ZADAXIN sales in Asia, Latin America and the
Middle East. 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. 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 six importers 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. 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. 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. 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. 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. We are aware that other companies
are marketing generic thymosin alpha 1 in China, possibly in violation of our
trademark or other rights, and we expect such violations of our rights to
continue. Moreover, the issuance of a patent 27




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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 up to 18 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. 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. Typically we have at any time only
one supplier for each phase of manufacturing of our product. If unanticipated
deficiencies in these suppliers occur, we could experience delays in our
ability to assemble a timely and acceptable NDA. 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. Not all of the ZADAXIN planned to be used in
our HCV clinical trials has been manufactured and received. Roche is our
exclusive supplier of pegylated interferon alpha for our current U.S. clinical
trials, and we have not received all the pegylated interferon to be used in the
clinical trials. Roches agreement with us to provide our supply of pegylated
interferon alpha can be terminated by them without cause on 30-days notice, in
which case we would need to purchase their product for use in the clinical
trials. Any delay in receiving, or a recall of, pegylated interferon alpha or
ZADAXIN, including by reason of Roches termination of its supply arrangement
with us, could delay the clinical trials or detract from the integrity of the
trial data. If any of the foregoing occurs, our ability to complete our
clinical trials in the United States and to market and sell ZADAXIN worldwide
will be delayed or impaired, our business will suffer and the price of our
stock may decline. We have been in the process of qualifying a new manufacturer
of ZADAXIN and if we encounter problems with this process of validation, our
sales or our clinical trials could be adversely affected. 28




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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 changing suppliers for ZADAXIN and such changes
require qualification of the new suppliers with regulatory agencies, quality
assurance and other steps which could cause delays or interruptions of supply.
If we do not obtain the required regulatory approvals for a manufacturing
change in a timely fashion, especially in China, our sales may be interrupted
until the manufacturing change is approved. Although we are increasing
inventories to prepare to manage any such occurrences, we may still experience
interruptions in supply which could adversely affect our results. 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. While we have limited sales of ZADAXIN in certain markets, we do not yet
have regulatory approval for ZADAXIN for our principal target markets, and, in
this respect, ZADAXIN is still being developed. Our other potential products
are in earlier stages of development than ZADAXIN. 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 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. 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 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 suffer. 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. 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 hurt 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. 29




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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 complete our
current U.S. phase 3 clinical trials and, if the trials are successful and we
receive FDA approval, to begin commercialization of ZADAXIN in the United
States. However, we cannot assure that such funds will be sufficient, or that
sales of ZADAXIN, if approved in the United States, will result in profitable
operations. In addition, we may need additional funds in the future 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 December 31, 2003, we had an accumulated deficit of approximately $138
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, particularly in the United
States, 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, which may
adversely affect our ability to successfully commercialize our products. We currently 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. 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 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
and/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 Europe. We generally do not
have control over the amount and timing of resources that our business partners
devote to ZADAXIN, 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 and/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. 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 are focused on developing ZADAXIN as a treatment for HCV and HBV and
certain cancers. Several large biopharmaceutical companies have substantial
commitments to interferon alpha, an approved drug for treating HBV and HCV, and
to lamivudine and adefovir, approved drugs to treat HBV. 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 HCV, HBV, cancer and other diseases that will be superior to
ours. 30




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If third-party reimbursement is not available or patients cannot otherwise pay
for ZADAXIN, we may not be able to successfully market ZADAXIN. Significant uncertainty exists as to the reimbursement status of new
therapeutic products, such as ZADAXIN. We cannot assure you that third-party
insurance coverage and reimbursement will be available for therapeutic products
we might develop. The failure to obtain third-party reimbursement for our
products, particularly in the United States, Europe and Japan, would harm our
business. Further, we cannot assure you that additional limitations will not be
imposed in the future in the United States 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 payors 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 will reduce our gross margins and may harm our business. 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 key personnel. 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 the
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. 31




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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:  
    
    results of clinical trials involving ZADAXIN;
    
    progress of ZADAXIN through the regulatory process,
especially regulatory actions in the United States and Japan;
    
    timing and achievement of milestones;
    
    announcements of technological innovations or new products by
us or our competitors;
    
    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 company assessments or financial estimates by
securities analysts;
    
    actual or anticipated fluctuations in our quarterly operating
results;
    
    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. As of December 31, 2003, stock options to purchase 5,533,718 shares of
common stock were outstanding, of which options to purchase 3,943,906 shares
were exercisable. Also outstanding as of the same date were warrants
exercisable for 904,760 shares of common stock at $7.00 per share and for
100,000 shares at $2.25 per share and two notes convertible into a total of
684,140 shares of common stock. The note holder has the right to purchase up to
$8.3 million of additional convertible notes due on or before March 2006,
which, if fully issued, will be convertible into 684,140 shares of our common
stock. Upon exercise of options or warrants, or conversion of the notes, these
issued shares of common stock will be freely tradable. 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 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 and Exchange Act of
1934. 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 March 2004, only one director has
adopted such a plan, with sales commencing no earlier than May 2004, and other
directors or officers may do so in the future. In general our officers and
directors 32




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have rarely sold stock in the Company, though they have held options or
stock for many years. We expect future sales by officers and directors either
under 10b5-1 plans or otherwise as result of 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, affecting the trading price of our stock. If our officers, directors and largest stockholders elect to act together, they
may be able to control our management and operations, acting in their best
interests and not necessarily those of other stockholders. As of December 31, 2003 our directors and officers owned or had the right
to acquire approximately 7.4% of the outstanding shares of our common stock.
Our two largest stockholders, Sigma-Tau (and its affiliates) and Randal J.
Kirk, owned in the aggregate approximately 15.2% of the outstanding shares of
our capital stock. As a result, due to their concentration of stock ownership,
our directors, officers and largest stockholders, if they act together, may be
able to influence our management and operation and may be able to affect or
influence all matters requiring a stockholder vote, including the election of
all directors and the amendment of charter documents or the approval of a
merger, sale of assets or other major corporate transactions. Although they are independent of each other and not part of a group, in
2003 we obtained the support of Sigma-Tau and Mr. Kirk for our proposal to the
stockholders to reincorporate in Delaware, and without that support we would
not have been able to obtain the required stockholder approval for that matter. 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 the stockholders.
Prior to our recent reincorporation in Delaware, we had a stockholder rights
plan, also commonly known as a poison pill, which we terminated in connection
with the reincorporation. We currently do not intend to adopt a stockholder
rights plan. However, our charter documents do 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. 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. To date, this
exposure to currency exchange rate fluctuations has been minimal because the
Chinese currency has been pegged to the U.S. dollar. However, the fixed nature
of the Chinese currency in relation to the U.S. dollar may not continue in the
future and, consequently, our foreign operations may expose us to greater risk
of 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. 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 operating results and stock price. 33




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Item 7A.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 solely 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 $149,464 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 December 31, 2003.
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 are denominated in euros and this exposes us to foreign currency
rate fluctuations. 34




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Item 8.Financial Statements and Supplementary Data SCICLONE PHARMACEUTICALS, INC. INDEX TO FINANCIAL STATEMENTS
Consolidated Financial Statements PageReport of Ernst & Young LLP, Independent Auditors
    
    
    36Consolidated Balance Sheets at December 31, 2003 and 2002
    
    
    37Consolidated Statements of Operations for each of the three years in the period ended December 31, 2003
    
    
    38Consolidated Statement of Stockholders Equity for the three years ended December 31, 2003
    
    
    39Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2003
    
    
    40Notes to Consolidated Financial Statements
    
    
    41
 35




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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders
SciClone Pharmaceuticals, Inc. We have audited the accompanying consolidated balance sheets of SciClone
Pharmaceuticals, Inc. as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders equity, and cash flows for
each of the three years in the period ended December 31, 2003. Our audits also
included the financial statement schedule listed at Item 15(a). These financial
statements and schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of SciClone
Pharmaceuticals, Inc. at December 31, 2003 and 2002, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein. /s/ Ernst & Young LLPPalo Alto, CaliforniaFebruary 13, 2004
 36




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SCICLONE PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS December 31,
    
    December 31,2003
    
    2002ASSETSCurrent assets:Cash and cash equivalents
    
    $
    52,899,000
    
    
    $
    10,233,000Restricted short-term investments
    
    
    695,000
    
    
    
    685,000Other short-term investments
    
    
    9,381,000
    
    
    
    10,232,000Accounts receivable, net of allowance of $638,000 in 2003 and 2002
    
    
    10,142,000
    
    
    
    9,276,000Inventories
    
    
    5,778,000
    
    
    
    3,431,000Prepaid expenses and other current assets
    
    
    2,456,000
    
    
    
    2,297,000Total current assets
    
    
    81,351,000
    
    
    
    36,154,000Property and equipment, net
    
    
    325,000
    
    
    
    111,000Intangible assets, net
    
    
    612,000
    
    
    
    682,000Other assets
    
    
    1,534,000
    
    
    
    164,000Total assets
    
    $
    83,822,000
    
    
    $
    37,111,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,423,000
    
    
    $
    3,150,000Accrued compensation and employee benefits
    
    
    1,440,000
    
    
    
    1,089,000Accrued clinical trials expense
    
    
    1,889,000
    
    
    
    966,000Accrued professional fees
    
    
    481,000
    
    
    
    679,000Deferred revenue
    
    
    537,000
    
    
    
    895,000Other accrued expenses
    
    
    631,000
    
    
    
    259,000Total current liabilities
    
    
    8,401,000
    
    
    
    7,038,000Deferred revenue
    
    
    671,000
    
    
    
    1,119,000Other long term liabilities
    
    
    900,000
    
    
    
    Convertible notes payable
    
    
    5,600,000
    
    
    
    5,600,000Commitments and contingenciesStockholders equity:Preferred stock; $0.001 par value; 10,000,000 shares
authorized; no shares
outstanding
    
    
    
    
    
    
    Common stock; $0.001 par value (no par value in 2002);
75,000,000 shares authorized; 44,484,144 and 36,904,916 shares
issued and outstanding in 2003 and 2002, respectively
    
    
    44,000
    
    
    
    156,290,000Additional paid-in capital
    
    
    206,320,000
    
    
    
    Accumulated other comprehensive income
    
    
    176,000
    
    
    
    79,000Accumulated deficit
    
    
    (138,290,000
    )
    
    
    (133,015,000
    )Total stockholders equity
    
    
    68,250,000
    
    
    
    23,354,000Total liabilities and stockholders equity
    
    $
    83,822,000
    
    
    $
    37,111,000
 See notes to consolidated financial statements. 37




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SCICLONE PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Year ended December 31,2003
    
    2002
    
    2001Revenues:Product sales
    
    $
    31,732,000
    
    
    $
    17,101,000
    
    
    $
    13,831,000Contract revenue
    
    
    806,000
    
    
    
    671,000
    
    
    
    Total revenues
    
    
    32,538,000
    
    
    
    17,772,000
    
    
    
    13,831,000Cost of product sales
    
    
    5,636,000
    
    
    
    3,487,000
    
    
    
    2,742,000Gross margin
    
    
    26,902,000
    
    
    
    14,285,000
    
    
    
    11,089,000Operating expenses:Research and development
    
    
    18,949,000
    
    
    
    11,647,000
    
    
    
    8,561,000Sales and marketing
    
    
    9,018,000
    
    
    
    8,724,000
    
    
    
    8,764,000General and administrative
    
    
    4,134,000
    
    
    
    3,902,000
    
    
    
    3,897,000Total operating expenses
    
    
    32,101,000
    
    
    
    24,273,000
    
    
    
    21,222,000Loss from operations
    
    
    (5,199,000
    )
    
    
    (9,988,000
    )
    
    
    (10,133,000
    )Interest and investment income
    
    
    266,000
    
    
    
    323,000
    
    
    
    751,000Interest expense
    
    
    (361,000
    )
    
    
    (361,000
    )
    
    
    (334,000
    )Other income (expense), net
    
    
    19,000
    
    
    
    (11,000
    )
    
    
    (13,000
    )Income from payment on note receivable from former officer
    
    
    
    
    
    
    
    
    
    
    3,497,000Net loss
    
    $
    (5,275,000
    )
    
    $
    (10,037,000
    )
    
    $
    (6,232,000
    )Basic and diluted net loss per share
    
    $
    (0.13
    )
    
    $
    (0.29
    )
    
    $
    (0.19
    )Weighted average shares used in computing basic and diluted net loss
per share
    
    
    39,568,199
    
    
    
    35,002,003
    
    
    
    32,356,287
 See notes to consolidated financial statements. 38




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##### Table of Contents



SCICLONE PHARMACEUTICALS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY AccumulatedCommon stock
    
    Additional
    
    othercomprehensive
    
    Accumulated
    

TotalstockholdersShares
    
    Amount
    
    paid-in capital
    
    income
    
    deficit
    
    equityBalance at December 31, 2000
    
    
    32,209,286
    
    
    $
    144,815,000
    
    
    $
    
    
    
    $
    8,000
    
    
    $
    (116,746,000
    )
    
    $
    28,077,000Issuance of common stock from
exercise
of stock options, warrants and
employee stock purchase plan
    
    
    264,864
    
    
    
    544,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    544,000Issuance of rights to purchase
convertible note
    
    
    
    
    
    
    354,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    354,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,232,000
    )
    
    
    (6,232,000
    )Net unrealized gain on
available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,000
    
    
    
    
    
    
    
    31,000Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,201,000
    )Balance at December 31, 2001
    
    
    32,474,150
    
    
    
    145,713,000
    
    
    
    
    
    
    
    39,000
    
    
    
    (122,978,000
    )
    
    
    22,774,000Issuance of common stock from
exercise
of stock options, warrants and
employee stock purchase plan
    
    
    342,306
    
    
    
    663,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    663,000Issuance of common stock from private
placements
    
    
    4,088,460
    
    
    
    9,914,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,914,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,037,000
    )
    
    
    (10,037,000
    )Net unrealized gain on
available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,000
    
    
    
    
    
    
    
    40,000Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,997,000
    )Balance at December 31, 2002
    
    
    36,904,916
    
    
    
    156,290,000
    
    
    
    
    
    
    
    79,000
    
    
    
    (133,015,000
    )
    
    
    23,354,000Issuance of common stock from
exercise
of stock options, warrants and
employee stock purchase plan
    
    
    847,171
    
    
    
    3,256,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,256,000Issuance of common stock to Sigma-Tau
    
    
    504,938
    
    
    
    1,800,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,800,000Reincorporation in Delaware
    
    
    
    
    
    
    (161,308,000
    )
    
    
    161,308,000
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock from
exercise
of stock options, warrants and
employee stock purchase plan
    
    
    227,119
    
    
    
    
    
    
    
    592,000
    
    
    
    
    
    
    
    
    
    
    
    592,000Issuance of common stock in secondary
offering, net of financing costs
    
    
    6,000,000
    
    
    
    6,000
    
    
    
    44,420,000
    
    
    
    
    
    
    
    
    
    
    
    44,426,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,275,000
    )
    
    
    (5,275,000
    )Net unrealized gain on
available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    97,000
    
    
    
    
    
    
    
    97,000Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,178,000
    )Balance at December 31, 2003
    
    
    44,484,144
    
    
    $
    44,000
    
    
    $
    206,320,000
    
    
    $
    176,000
    
    
    $
    (138,290,000
    )
    
    $
    68,250,000
 See notes to consolidated financial statements. 39




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##### Table of Contents



SCICLONE PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31,2003
    
    2002
    
    2001Operating activities:Net loss
    
    $
    (5,275,000
    )
    
    $
    (10,037,000
    )
    
    $
    (6,232,000
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    185,000
    
    
    
    556,000
    
    
    
    556,000Non-cash interest income
    
    
    (13,000
    )
    
    
    (21,000
    )
    
    
    (34,000
    )Non-cash gain on equity securities
    
    
    
    
    
    
    
    
    
    
    (52,000
    )Gain from payment on note receivable from former officer
    
    
    
    
    
    
    
    
    
    
    (3,497,000
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (866,000
    )
    
    
    (484,000
    )
    
    
    (171,000
    )Inventories
    
    
    (2,347,000
    )
    
    
    628,000
    
    
    
    (2,039,000
    )Prepaid expenses and other assets
    
    
    (355,000
    )
    
    
    (967,000
    )
    
    
    (205,000
    )Accounts payable and other accrued expenses
    
    
    345,000
    
    
    
    1,576,000
    
    
    
    (603,000
    )Accrued clinical trials expense
    
    
    923,000
    
    
    
    670,000
    
    
    
    94,000Accrued professional fees
    
    
    (198,000
    )
    
    
    46,000
    
    
    
    (32,000
    )Accrued compensation and employee benefits
    
    
    352,000
    
    
    
    129,000
    
    
    
    173,000Deferred revenue
    
    
    (806,000
    )
    
    
    2,014,000
    
    
    
    Net cash used in operating activities
    
    
    (8,055,000
    )
    
    
    (5,890,000
    )
    
    
    (12,042,000
    )Investing activities:Purchase of property and equipment
    
    
    (303,000
    )
    
    
    (66,000
    )
    
    
    (99,000
    )Proceeds from sales of short-term investments
    
    
    1,000,000
    
    
    
    94,000
    
    
    
    Proceeds from maturity of short-term investments
    
    
    500,000
    
    
    
    2,600,000
    
    
    
    4,000,000Payments on purchases of short-term investments
    
    
    (550,000
    )
    
    
    (6,600,000
    )
    
    
    (10,317,000
    )Net cash provided by (used in) investing activities
    
    
    647,000
    
    
    
    (3,972,000
    )
    
    
    (6,416,000
    )Financing activities:Proceeds from issuance of common stock, net
    
    
    50,074,000
    
    
    
    10,577,000
    
    
    
    898,000Payment on note receivable from former officer
    
    
    
    
    
    
    
    
    
    
    3,497,000Proceeds from issuance of convertible note
    
    
    
    
    
    
    
    
    
    
    1,600,000Net cash provided by financing activities
    
    
    50,074,000
    
    
    
    10,577,000
    
    
    
    5,995,000Net increase (decrease) in cash and cash equivalents
    
    
    42,666,000
    
    
    
    715,000
    
    
    
    (12,463,000
    )Cash and cash equivalents, beginning of year
    
    
    10,233,000
    
    
    
    9,518,000
    
    
    
    21,981,000Cash and cash equivalents, end of year
    
    $
    52,899,000
    
    
    $
    10,233,000
    
    
    $
    9,518,000Supplemental disclosures of cash flow information:Cash paid for interest
    
    $
    336,000
    
    
    $
    336,000
    
    
    $
    308,000Non-cash Investing activities:Obligations related to prepaid royalties
    
    $
    1,200,000
    
    
    $
    
    
    
    $
    
 See notes to consolidated financial statements. 40




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##### Table of Contents



SCICLONE PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1  The Company and Summary of Significant Accounting Policies The Company SciClone Pharmaceuticals, Inc. (SciClone or the Company) is a
biopharmaceutical company engaged in the development and commercialization of
therapeutics to treat life-threatening diseases. The Companys lead product
ZADAXIN is in several late-stage clinical trials, including two phase 3
hepatitis C clinical trials in the United States, a recently completed phase 3
hepatitis B clinical trial in Japan, an ongoing phase 2 malignant melanoma
clinical trial in Europe with its exclusive European marketing partner,
Sigma-Tau, two ongoing phase 2 pilot studies in the United States for the
treatment of liver cancer and an ongoing HCV pilot study in Mexico. ZADAXIN has
been approved for sale by the ministries of health in over 30 countries and is
marketed in China and selected other countries outside the U.S. primarily for
the treatment of hepatitis B and hepatitis C. Basis of Presentation The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, SciClone Pharmaceuticals International
Limited, SciClone Italy S.R.L., SciClone Japan K.K., and SciClone do Brasil -
Produtos Farmaceuticos Ltda. SciClone Pharmaceuticals International Limited is
registered in the Cayman Islands with its principal office located in Hong
Kong. SciClone Italy S.R.L. is registered in Italy with its principal office
located in Rome. SciClone Japan K.K. is registered in Japan with its principal
office located in Tokyo. SciClone do Brasil is registered in Brazil with its
principal office located in Sao Paulo. All significant intercompany accounts
and transactions have been eliminated. 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. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. Cash Equivalents and Investments Cash equivalents consist of highly liquid investments with original
maturities of three months or less. All cash equivalents are carried at cost
plus accrued interest, which approximates market value. The Company is required by its lease agreement to have a letter of credit
secured by a certificate of deposit of $633,000 at December 31, 2003. Under its
European value added tax filing arrangement, the Company has a letter of credit
secured by a certificate 41




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of deposit of $62,000 at December 31, 2003. These amounts are recorded as
restricted short-term investments on the accompanying balance sheets. The Company classifies its entire investment portfolio as
available-for-sale and records these investments at fair value, as determined
by available market information, on the balance sheet. The portfolio primarily
consists of U.S. Government securities and short-term municipals. Unrealized
gains or losses are included in accumulated other comprehensive income on the
consolidated balance sheet. The amortized cost of debt securities is adjusted
for amortization of premiums and accretion of discounts to maturity. Such
amortization is included in investment income along with interest earned.
Realized gains or losses are determined on the basis of specific
identification. Management believes the credit risk associated with these
investments is limited due to the nature of the investments. For the years ended December 31, 2003, 2002 and 2001, net unrealized gains
of approximately $97,000, $40,000 and $31,000, respectively, were included in
accumulated other comprehensive income. For the years ended December 31, 2003,
2002 and 2001, net realized gains were less than $1,000 for all years. Fair Value of Financial Instruments The fair value of our cash equivalents and marketable securities is based
on quoted market prices. The carrying amount of cash equivalents and
marketable securities are equal to their respective fair values at December 31,
2003 and 2002. Other financial instruments, including accounts receivable, accounts
payable and accrued liabilities, are carried at cost, which we believe
approximates fair value because of the short-term maturity of these
instruments. We believe the reported value of our convertible debt of
$5,600,000 at December 31, 2003 and 2002 approximates the fair value. Inventories Inventories are stated at the lower of cost (first-in, first-out basis) or
market. Property and Equipment Property and equipment is stated at cost, less accumulated depreciation.
Depreciation is recorded over the estimated useful lives of the respective
assets (three to five years) on the straight-line basis. Leasehold improvements
are amortized over the shorter of the estimated useful life or lease term on
the straight-line basis. Depreciation expense for the years ended December 31,
2003, 2002 and 2001 was $90,000, $122,000 and $146,000, respectively. Intangible Assets Intangible assets include the following: December 31,2003
    
    2002Intangible product rights
    
    $
    2,456,000
    
    
    $
    2,456,000Accumulated amortization
    
    
    (1,844,000
    )
    
    
    (1,774,000
    )$
    612,000
    
    
    $
    682,000
 In December 1997 the Company entered into an agreement with Alpha 1
Biomedicals, Inc. (A1B) to acquire the worldwide rights, except in Italy,
Spain and Portugal, where Sclavo S.p.A. (Sclavo), an international
pharmaceutical entity, owned exclusive marketing rights, to ZADAXIN, which
rights A1B had licensed from Hoffmann-LaRoche, Inc. and F. Hoffmann-LaRoche AG,
for approximately $1,800,000. The transaction closed in July 1998 and
eliminated the Companys royalty obligation to A1B with respect to all sales of
ZADAXIN after the acquisition date. In April 1998, the Company entered into an
agreement with Sclavo to acquire ZADAXIN rights for Italy, Spain and Portugal
from Sclavo for approximately $1,400,000. In connection with the foregoing transactions with Sclavo and A1B, the
Company estimated the fair market value of the intangible assets purchased to
be approximately $2,456,000 and wrote off the remaining $700,000 related to
hepatitis C in-process technology. Acquired ZADAXIN product rights are being amortized on a straight-line
basis beginning in September 1998. Amortization expense for the years ended
December 31, 2002 and 2001 was $409,000 per year based on an estimated useful
life of six years. 42




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Amortization expense for the year ended December 31, 2003 was $70,000 and
for the years 2004 through 2012 is expected to be $70,000 per year. The
Company has reassessed the estimated useful life of the assets as of January 1,
2003 to be an additional eight years through 2012. 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 reassesses the useful life of
these assets in accordance with current facts and circumstances. 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.
The Company to date has not identified any impairment losses on these assets.
Although the Company has a history of operating and cash flow losses, the
Company believes that there is no impairment to the intangible assets because
ZADAXIN has been approved for sale in over 30 countries, principally as a
treatment for hepatitis B or hepatitis C. Based on the Companys anticipated
financial results for ZADAXIN sales from 2003 to 2007, it has been determined
that the future cash flows exceed the carrying amount of the assets. Foreign Currency Translation The Company translates the assets and liabilities of its foreign
subsidiaries stated in local functional currencies to U.S. dollars at the rates
of exchange in effect at the end of the period. Revenues and expenses are
translated using rates of exchange in effect during the period. Gains and
losses from the translation of financial statements denominated in foreign
currencies, if material, are included as a separate component of other
comprehensive income (loss) in the statement of stockholders equity. There
have been no accumulated currency translation gains or losses included in any
period presented. The Company records foreign currency transactions at the exchange rate
prevailing at the date of the transaction. Monetary assets and liabilities
denominated in foreign currency are retranslated at the exchange rates in
effect at the balance sheet date. All translation differences arising from
foreign currency transactions are included in results of operations and have
not been significant. Research and Development Expenses Research and development expenditures are charged to operations as
incurred. Major components of research and development expenses consist of
clinical development performed on our behalf by institutions and contract
research organizations, personnel costs, including salaries and benefits,
preclinical work, pharmaceutical development, materials and supplies, third
party research funding and overhead allocations consisting of various
administrative and facilities related costs. SciClones research and
development activities are also separated into three main categories: research,
clinical development and pharmaceutical development. Research costs typically
consist of preclinical and toxicology work. Clinical development costs include
Phase 1, 2 and 3 clinical trials as well as expanded access programs.
Pharmaceutical development costs consist of product formulation and chemical
analysis. The continuation of ZADAXIN clinical trials have had, and are expected to
continue to have, the largest and most significant effect on the Companys
research and development expenses. Cost accruals for clinical trials are based
on estimates of the services received and efforts expended pursuant to
contracts with numerous institutions that conduct the clinical trials on the
Companys behalf. The financial terms of these agreements are subject to
negotiation and variation from contract to contract and may result in uneven
payment flows. Payments under the contracts depend on factors such as the
achievement of certain events, the successful enrollment of patients and the
completion of portions of the clinical trial or similar conditions. The
objective of the accrual policy is to match the recording of expenses to the
actual services received and efforts expended. Expenses related to grants to
institutions that conduct the clinical trials on the Companys behalf are
accrued based on the level of patient enrollment and activity according to the
protocol. In general, these expenses will be higher for the initial and final
months of a patients scheduled 18 months of treatment and observation.
Expenses relating to the clinical research organization (CRO) managing the
trials and laboratory and other direct expenses are recognized in the period
they are incurred and the services performed. The Company monitors patient
enrollment levels and related activity to the extent possible and adjusts
estimates accordingly however, if management has underestimated activity levels
associated with various studies at a given point in time, the actual research
and development expenses could be underestimated. Shipping and Handling Costs Costs related to shipping and handling are included in cost of sales for
all periods presented. 43




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Advertising Expenses The Company expenses advertising costs as incurred and these costs are
included in sales and marketing expenses for all periods presented. Advertising
expenses for the years ended December 31, 2003, 2002 and 2001 were $255,000,
$108,000 and $233,000, respectively. Income Taxes Income taxes are accounted for under the liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis, and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that included the enactment date.
Deferred tax assets are reduced by a valuation allowance when, in the opinion
of management, it is more likely than not that some or all of the deferred tax
assets may not be realized. Net Loss Per Share Basic net loss per share has been computed using the weighted average
number of shares of common stock outstanding during the period. Diluted net
loss per share equals basic net loss per share given the Companys history of
net losses. Had the Company been in a net income position, diluted earnings per share
would have included the shares used in the computation of basic net loss per
share as well as an additional 7,906,758, 8,436,262 and 8,265,637 shares in
2003, 2002 and 2001, respectively, related to convertible notes payable,
outstanding options and warrants regardless of conversion or exercise prices,
not included in the calculation of basic net loss per share. Accounting for Stock-Based Compensation The Company accounts for its stock option and employee stock purchase
plans under the provisions of Accounting Principles Board Opinion 25 (APB 25)
and related Interpretations. Accordingly, the Company does not generally
recognize compensation expense in accounting for its stock option and employee
stock purchase plans for awards to employees and directors. Pro forma information regarding net loss and net loss per share is
required by Statement of Financial Accounting Standards No. 123 Accounting for
Stock-Based Compensation (SFAS 123) and has been determined as if the
Company had accounted for its stock awards under the fair value method of that
Statement. The fair value for the options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 2003, 2002 and 2001: risk-free interest rates of 2.00%, 2.00%
and 4.00%, respectively; dividend yield of 0%; volatility factors of the
expected market price of the Companys common stock of 0.93, 0.96 and 0.96,
respectively, and a weighted average expected life of the option of 4.03 years,
3.88 years and 3.94 years, respectively. The weighted average estimated fair
value of options granted was $4.10 for 2003, $2.75 for 2002 and $2.72 for 2001.
The fair value for the employee stock purchases was also estimated using the
Black-Scholes model with the following assumptions for 2003, 2002 and 2001:
risk-free interest rate of 2.00%, 2.00% and 4.00%, respectively; dividend yield
of 0%; expected volatility of 0.94, 0.96 and 0.96, respectively, and expected
life of 0.25 years. The weighted average estimated fair value of the employee
stock purchase plan shares purchased was $1.74 for 2003, $0.99 for 2002 and
$1.86 for 2001. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Companys employee stock awards have characteristics
significantly different from those of traded options, and because changes in
subjective input assumptions can materially affect the fair value estimate, in
the Companys opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options and
stock purchases. Had compensation expense for the Companys option and employee purchase
plans been determined based on the fair value at the grant date for awards in
2003, 2002 and 2001 consistent with the provisions of SFAS 123, the Companys
net loss and net loss per share would have been adjusted to the pro forma
amounts for the years ended December 31 as indicated below: 44




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2003
    
    2002
    
    2001Net loss  as reported
    
    $
    (5,275,000
    )
    
    $
    (10,037,000
    )
    
    $
    (6,232,000
    )Total stock-based employee compensation expense
determined under the fair value based method for
all awards
    
    
    (3,010,000
    )
    
    
    (2,283,000
    )
    
    
    (2,756,000
    )Net loss  pro forma
    
    $
    (8,285,000
    )
    
    $
    (12,320,000
    )
    
    $
    (8,988,000
    )Basic and diluted net loss per share  as
reported
    
    $
    (0.13
    )
    
    $
    (0.29
    )
    
    $
    (0.19
    )Basic and diluted net loss per share  pro
forma
    
    $
    (0.21
    )
    
    $
    (0.35
    )
    
    $
    (0.28
    )
 The effects of applying SFAS 123 for pro forma disclosures are not likely
to be representative of the effects on reported net loss for future years due
to the different number of options granted each year. Warrants issued in connection with equity and debt arrangements and equity
instruments issued to non-employees are valued using the Black-Scholes option
valuation model. Warrants issued to placement agents and similar parties in
connection with equity financing are accounted for as stock issuance costs with
an equal amount recorded as additional paid-in capital. Warrants issued to
purchasers of the Companys equities are not separately included in the
financial statements as their value is a sub-component of additional paid-in
capital. The fair value of warrants issued in connection with debt
arrangements, if material, is accounted for as a debt discount and amortized as
additional interest expense over the term of the related debt. Comprehensive Income (Loss) The Company reports changes in unrealized gains or losses on the Companys
available-for-sale securities in comprehensive income (loss). The accumulated
other comprehensive income balances represent the unrealized gains on these
securities at the balance sheet dates. Segment Information The Company operates in one segment (see Note 9). Concentration of Credit Risk The Peoples Republic of China, like Japan and certain other Asian
markets, uses a tiered method to import and distribute products. The
distributors make the sales in the country, but the product is imported for
them by licensed importers. For the year ended December 31, 2003, sales to five
importing agents in China accounted for 88% of the Companys product sales and
sales to six importing agents accounted for 88% of product sales for the year
ended December 31, 2002 and sales to four importing agents accounted for 89% of
product sales in 2001. In 2003, the largest customer accounted for 52% of sales
and the second largest customer accounted for 14% of sales. No other customers
accounted for more than 10% of sales in 2003. In 2002, the largest customer
accounted for 41% of sales and the second largest customer accounted for 27% of
sales. No other customers accounted for more than 10% of sales in 2002. In
2001, the largest customer accounted for 47% of sales and the second largest
customer accounted for 30% of sales. No other customers accounted for more than
10% of sales in 2001. As of December 31, 2003, approximately $9,112,000, or 85%
of the Companys accounts receivable were attributable to four importing agents
in China. The Company performs on-going credit evaluations of its customers
financial condition, and generally does not require collateral from its
customers. The Company maintains reserves for credit losses, and such losses
have been within managements expectation. The Company recognizes reserves for
bad debts ranging from 25% to 100% based on the length of time the receivables
are past due and the Companys collectibility experience. Reclassifications The Company has made certain classification changes to the consolidated
balance sheets and also the consolidated statements of cash flow statement as
appropriate. For December 31, 2002, $10,000,000 was reclassified from cash and
cash equivalent to other short-term investments. 45




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##### Table of Contents



Note 2  Available-for-sale Securities The following is a summary of available-for-sale securities: Available-For Sale SecuritiesGrossAmortized
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Fair ValueDecember 31, 2003:Certificates of deposit
    
    $
    798,000
    
    
    $
    
    
    
    $
    798,000U.S. government obligations
    
    
    38,259,000
    
    
    
    
    
    
    
    38,259,000Short-term municipal
securities
    
    
    9,050,000
    
    
    
    
    
    
    
    9,050,000Corporate equity securities
    
    
    51,000
    
    
    
    176,000
    
    
    
    227,000$
    48,158,000
    
    
    $
    176,000
    
    
    $
    48,334,000December 31, 2002:Certificates of deposit
    
    $
    787,000
    
    
    $
    
    
    
    $
    787,000U.S. government obligations
    
    
    3,723,000
    
    
    
    
    
    
    
    3,723,000Short-term municipal
securities
    
    
    10,000,000
    
    
    
    
    
    
    
    10,000,000Corporate equity securities
    
    
    51,000
    
    
    
    79,000
    
    
    
    130,000$
    14,561,000
    
    
    $
    79,000
    
    
    $
    14,640,000
 As of December 31, 2003, the total available-for-sale securities are
included on the accompanying balance sheets as follows, $38,259,000 in cash and
cash equivalents, $695,000 in restricted short-term investments and $9,380,000
in other short-term investments. As of December 31, 2002, the total
available-for-sale securities are included as follows, $3,723,000 in cash and
cash equivalents, $685,000 in restricted short-term investments and $10,232,000
in other short-term investments. As of December 31, 2003 and 2002 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 these securities is limited due to this interest rate reset
mechanism. Note 3  Inventories Inventories consisted of the following: December 31,2003
    
    2002Raw materials
    
    $
    1,577,000
    
    
    $
    2,190,000Work in progress
    
    
    1,955,000
    
    
    
    159,000Finished goods
    
    
    2,246,000
    
    
    
    1,082,000$
    5,778,000
    
    
    $
    3,431,000
 Note 4  Property and Equipment Property and equipment consisted of the following: December 31,2003
    
    2002Office furniture and fixtures
    
    $
    243,000
    
    
    $
    134,000Office equipment
    
    
    667,000
    
    
    
    504,000Leasehold improvements
    
    
    121,000
    
    
    
    121,0001,031,000
    
    
    
    759,000Less accumulated depreciation and amortization
    
    
    (706,000
    )
    
    
    (648,000
    )Net property and equipment
    
    $
    325,000
    
    
    $
    111,000
 Note 5  Collaborative Agreements In October 2003, the Company and Wayne State University (WSU) amended a
license agreement that WSU and A1B had entered into in 1994 that was
subsequently assigned by A1B to SciClone. The 2003 amendment allows the
Company to maintain an 46




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##### Table of Contents



exclusive license to certain WSU patents regarding the use of thymosin
alpha 1 in the treatment of hepatitis B and hepatitis C. In addition to
certain minimum royalty payments on sales of ZADAXIN in certain territories,
the Company is obligated to pay WSU a total of $1,400,000 in pre-paid royalties
over the following three years whether or not the Company receives regulatory
approval for ZADAXIN or sales are made in the covered territories including the
United States. The Company can offset the annual minimum royalties due on
sales of ZADAXIN with these pre-paid royalties to the extent of 50% of the
annual royalties in any one year. In the year ended December 31, 2003, the
Company paid $200,000 of the pre-paid royalties. This amount plus the unpaid
balance of $1,200,000 that is due over the following three years, have been
recorded as pre-paid royalties in the long term other assets account on the
accompanying balance sheets. The remaining obligation to pay $1,200,000 has
been included in other accrued expenses and other long term liabilities on the
accompanying balance sheets. In April 1999, the Company licensed to Sigma-Tau semi-exclusive ZADAXIN
development and marketing rights in Italy and Spain, and exclusive rights in
Switzerland. In March 2000, this license was expanded and amended to include
all of the countries then in the European Union and Sigma-Tau was made
exclusive licensee in these countries. In December 2001, this license was
further amended to define the scope of clinical development for ZADAXIN that
Sigma-Tau would undertake in Europe. Under the terms of the December 2001
amendment, the Company received $2,685,000 in the first quarter of 2002. This
contract revenue is being recognized over the estimated time to complete the
ZADAXIN hepatitis C U.S. clinical program and deliver the clinical data, the
substantive performance requirements under the contract amendment. Upon full
enrollment of the Companys current phase 3 U.S. clinical trials, the Company
will earn a $1,000,000 milestone payment from Sigma-Tau. For the year ended
December 31, 2003 and 2002, the Company recognized $806,000 and $671,000,
respectively, as contract revenue and the remaining $1,208,000 is recorded as
deferred revenue as of December 31, 2003. In August 1997 the Company entered into a ZADAXIN Patent License Agreement
with The Fitzsimons Army Medical Center of the U.S. Army (the U.S. Army). The
Company is obligated to pay the U.S. Army a minimum annual royalty and a
royalty based on a percentage of ZADAXIN net sales revenue upon
commercialization of ZADAXIN for treatment of chronic hepatitis C in certain
countries, including the U.S., the European Union and Japan, but not including
China. In October 1996, the Company entered into an agreement with
Schering-Plough K.K., giving Schering-Plough K.K. exclusive marketing rights to
ZADAXIN in Japan. Under the agreement, Schering-Plough K.K. initiated
development of ZADAXIN as a monotherapy for the treatment of hepatitis B and
hepatitis C. Initially, Schering-Plough K.K. managed the development process
and the parties shared certain development expenses. In 2000, the Company
amended its agreement with Schering-Plough K.K. to allow the Company to
participate directly in the development process, and the Company now manages
and pays the expenses for the process through its wholly owned subsidiary,
SciClone Japan K.K., using a Japanese clinical research organization, and
Schering-Plough K.K. as a consultant. Schering-Plough K.K. continues to have
exclusive marketing rights to ZADAXIN in Japan. Note 6  Income Taxes The domestic and foreign components of pre tax income (loss) for the
years ended December 31 are as follows: 2003
    
    2002
    
    2001Domestic
    
    $
    (15,768,000
    )
    
    $
    (9,510,000
    )
    
    $
    (4,445,000
    )Foreign
    
    
    10,493,000
    
    
    
    (527,000
    )
    
    
    (1,787,000
    )Loss
    
    $
    (5,275,000
    )
    
    $
    (10,037,000
    )
    
    $
    (6,232,000
    )
 Significant components of the Companys deferred tax assets at December 31
are as follows: 2003
    
    2002AssetsNet operating loss carryforwards
    
    $
    30,212,000
    
    
    $
    25,133,000R&D credit carryforwards
    
    
    5,238,000
    
    
    
    4,466,000Other
    
    
    1,095,000
    
    
    
    1,121,000Gross deferred tax assets
    
    
    36,545,000
    
    
    
    30,720,000Valuation allowance
    
    
    (36,545,000
    )
    
    
    (30,720,000
    )Total deferred tax assets
    
    $
    
    
    
    $
    
 The valuation allowance increased by approximately $5,825,000, $3,272,000
and $1,734,000 in the years ended December 31, 2003, 2002 and 2001,
respectively. Deferred tax assets relating to carryforwards as of December 31,
2003 include approximately 47




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##### Table of Contents



$7,503,000 associated with stock option activity for which any
subsequently recognized tax benefits will be credited directly to stockholders
equity. The Company did not have any deferred tax liabilities at December 31,
2003 or 2002. At December 31, 2003, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $86,000,000 which expire in the
years 2006 through 2023. The difference between the cumulative losses for
financial reporting purposes and federal income tax purposes is primarily
attributable to losses incurred by the Companys foreign subsidiaries. At
December 31, 2003, the Company has federal tax credit carryforwards of
approximately $4,900,000 which expire in the years 2006 through 2023. Because of the change in ownership provisions of the Internal Revenue
Code, a portion of the Companys net operating loss carryforwards and tax
credit carryforwards may be subject to an annual limitation regarding their
utilization against taxable income in future periods. As a result of the annual
limitation, a portion of these carryforwards may expire before ultimately
becoming available to reduce future income tax liabilities. As a result of net losses and valuation allowances, the Company did not
record any state income tax expense for the years ended December 31, 2003, 2002
and 2001. Note 7  Commitments and Contingencies Leases The Company leases its main office facility under a non-cancelable
operating lease agreement which expires in August 2007. The lease is for a
period of seven years and requires the Company to pay insurance and taxes and
its pro-rata share of operating expenses. The Company also leases various
office facilities abroad under non-cancelable lease agreements, expiring in
2005. Rent expense in 2003, 2002 and 2001 was $1,362,000, $1,376,000 and
$1,296,000, respectively. Minimum future rental payments amount to a total of
$4,958,000, which consists of $1,383,000 in 2004, $1,422,000 in 2005,
$1,280,000 in 2006 and $873,000 in 2007. Royalties Under the October 2003 amendment to the Patent License Agreement with
Wayne State University, the Company is obligated to pay WSU a royalty, subject
to minimum amounts, on a percentage of ZADAXIN net sales revenue for the
treatment of hepatitis B and hepatitis C in certain countries including the
U.S., the European Union and Japan, but not including China. In addition, the
Company is obligated to pay WSU pre-paid royalties of $300,000, $400,000 and
$500,000 in 2004, 2005 and 2006, respectively, whether or not the Company
receives regulatory approval for ZADAXIN or sales are made in the covered
territories including the United States. The Company can offset the annual
minimum royalties due on sales of ZADAXIN with these pre-paid royalties to the
extent of 50% of the annual royalties in any one year. In the year ended
December 31, 2003, the Company paid WSU $200,000 of pre-paid royalties. Under the August 1997 ZADAXIN Patent License Agreement with the U.S. Army,
the Company is obligated to pay the U.S. Army a minimum annual royalty and a
royalty based on a percentage of ZADAXIN net sales revenue upon
commercialization of ZADAXIN for treatment of chronic hepatitis C in certain
countries including the U.S., the European Union and Japan, but not including
China. During 2003, 2002 and 2001 the Company paid $20,000 per year related to
the minimum annual royalty. Convertible Notes Payable In March 2001, the Company issued a $1,600,000 convertible note with an
investment affiliate of UBS AG. The $1,600,000 note is convertible into 276,530
shares of common stock at a fixed conversion price of $5.7860 per share. The
note accrues interest at a rate of 6% per year payable semi-annually and will
mature in March 2006. The Company also received $354,000 for granting the
investor the right to purchase, at any time up to the notes maturity date,
approximately $2,400,000 of convertible notes due March 2006. If issued, the
notes will bear no interest (zero coupon) and will be convertible into 276,530
shares of common stock at a fixed conversion price of $8.5532 per share. The
Company may elect in lieu of delivering convertible notes to deliver the
respective number of shares of common stock. In December 2000, the Company issued a $4,000,000 convertible note with an
investment affiliate of UBS AG. The $4,000,000 note is convertible into 407,610
shares of common stock at a fixed conversion price of $9.8133 per share. The
note will accrue interest at a rate of 6% per year payable semi-annually and
will mature in December 2005. The Company also received $900,000 for granting
the investor the right to purchase, at any time up to the notes maturity date,
approximately $5,900,000 of convertible notes due 48




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##### Table of Contents



December 2005. If issued, the notes will bear no interest (zero coupon)
and will be convertible into 407,610 shares of common stock at a fixed
conversion price of $14.5066 per share. The Company may elect in lieu of
delivering convertible notes to deliver the respective number of shares of
common stock. Note 8  Stockholders Equity On July 18, 2003, the Company reincorporated from a California corporation
to a Delaware corporation by merging the Company, then a California
corporation, with and into SciClone Pharmaceuticals Inc., a Delaware
corporation and wholly-owned subsidiary of the Company. Each share of the
outstanding stock of the California corporation was automatically exchanged for
a like share of stock of the Delaware corporation. Common Stock and Warrants In September 2003, the Company completed a public follow-on offering of
6,000,000 shares of common stock at $8.00 per share and received proceeds of
$45,120,000 from the sale, net of $694,000 of financing-related costs. In January 2003, the Company completed a $1,800,000 direct placement to
affiliates of Sigma-Tau less $13,000 in financing-related costs. The affiliates
purchased 504,938 shares of the Companys common stock at $3.5648 per share.
The shares issued were restricted securities, and Sigma-Tau and its affiliates
are not permitted to sell any of the shares purchased in this private placement
until January 24, 2004. In June 2002, the Company completed a direct offering of common stock to
institutional investors. The Company raised net proceeds of $9,914,000 from the
offering of 4,088,460 shares of common stock at $2.60 per share. In March 2000, the Company licensed to Sigma-Tau exclusive development and
marketing rights to ZADAXIN in Europe. In addition, the Company completed a
$3,100,000 million private placement to Sigma-Tau consisting of 198,072 shares
of common stock, five-year immediately exercisable warrants to purchase 200,000
shares of common stock at $15.67 per share and five-year immediately
exercisable warrants to purchase 200,000 shares of common stock at $31.33 per
share. Sigma-Tau has no registration rights with respect to the shares
purchased. In January 2003, all of Sigma-Taus warrants were cancelled in
advance of the direct placement to affiliates of Sigma   Tau described above. In January 2000, the Company completed a $6,100,000 private placement to
Brown Simpson Asset Management which purchased 1,000,000 shares of common stock
at a price of $6.00 per share and five-year immediately exercisable warrants to
purchase 800,000 shares of common stock at an exercise price of $7.00 per
share. As of December 31, 2003, none of these warrants had been exercised. In
addition, the placement agent for this transaction received, as part of its
fee, five-year warrants to purchase 108,000 shares of common stock at an
exercise price of $7.00 per share. In 2003, warrants to purchase 3,240 shares
of common stock were exercised for proceeds of $22,680. As of December 31,
2003, placement agent warrants to purchase 104,760 of common stock had not been
exercised. In January 1999, the Company issued warrants to purchase a total of
150,000 shares of common stock to Cato Research Ltd. as part of a settlement
agreement. Of this total, warrants to purchase 50,000 shares of common stock
were exercised at a price of $1.225 for proceeds of $61,250 in March 2000 and
warrants to purchase 100,000 shares of common stock at an exercise price of
$2.25 were outstanding at December 31, 2003. In January 2004, warrants to
purchase 100,000 shares of common stock were exercised at a price of $2.25 in a
cashless exchange for 65,753 shares of common stock. 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 49




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##### Table of Contents



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. Under the 1991, 1992 and 1995 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. In June 1995, the Board of Directors and the stockholders of the Company
approved the Nonemployee Director Stock Option Plan (the Nonemployee Director
Plan) and reserved 250,000 shares for issuance thereunder. The Nonemployee
Director 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. Initial Grants
vest annually over a period of three years. Annual Grants vest monthly over a
period of one year. In June 2000 and June 2002 the Board of Directors and
stockholders of the Company approved 250,000 increases in the shares reserved
for issuance under the Nonemployee Director Plan. In May 2002, the stockholders
of the Company approved to increase the Annual Grant from 10,000 shares to
20,000 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. 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 127,920, 67,160 and 33,009 shares to employees in
2003, 2002 and 2001, respectively. The following table summarizes the stock option activity under the 1991,
1992 and 1995 Plans and the Nonemployee Director Plan: Options OutstandingWeightedShares
    
    Number
    
    AverageAvailable For
    
    of
    
    ExerciseGrant
    
    Shares
    
    PriceBalance at December 31, 2000
    
    
    1,878,972
    
    
    
    4,426,077
    
    
    $
    5.00Options canceled
    
    
    214,415
    
    
    
    (214,415
    )
    
    
    7.27Options granted
    
    
    (946,800
    )
    
    
    946,800
    
    
    
    3.98Options exercised
    
    
    
    
    
    
    (231,605
    )
    
    
    1.83Plan shares expired
    
    
    (120,718
    )
    
    
    
    
    
    
    Balance at December 31, 2001
    
    
    1,025,869
    
    
    
    4,926,857
    
    
    
    4.861995 Plan shares reserved
    
    
    1,350,000
    
    
    
    
    
    
    
    Nonemployee Director Plan shares reserved
    
    
    250,000
    
    
    
    
    
    
    
    Options canceled
    
    
    349,979
    
    
    
    (349,979
    )
    
    
    6.67Options granted
    
    
    (795,500
    )
    
    
    795,500
    
    
    
    4.13Options exercised
    
    
    
    
    
    
    (274,896
    )
    
    
    1.87Plan shares expired
    
    
    (126,542
    )
    
    
    
    
    
    
    Balance at December 31, 2002
    
    
    2,053,806
    
    
    
    5,097,482
    
    
    
    4.76Options canceled
    
    
    345,168
    
    
    
    (345,168
    )
    
    
    7.43Options granted
    
    
    (1,162,034
    )
    
    
    1,162,034
    
    
    
    6.17Options exercised
    
    
    
    
    
    
    (380,630
    )
    
    
    2.76Plan shares expired
    
    
    (79,697
    )
    
    
    
    
    
    
    Balance at December 31, 2003
    
    
    1,157,243
    
    
    
    5,533,718
    
    
    
    5.02
 50




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##### Table of Contents



The following table summarizes information concerning outstanding and
exercisable options as of December 31, 2003: Options Outstanding
    
    Options ExercisableWeightedAverage
    
    Weighted
    
    
    
    
    
    WeightedRemaining
    
    Average
    
    
    
    
    
    AverageNumber
    
    Contractual
    
    Exercise
    
    Number
    
    ExerciseRange of Exercise Prices
    
    Outstanding
    
    Life
    
    Price
    
    Exercisable
    
    Price$1.22 - $2.38
    
    
    1,100,556
    
    
    
    5.19
    
    
    $
    1.60
    
    
    
    1,100,556
    
    
    $
    1.60$2.47 - $3.84
    
    
    969,665
    
    
    
    6.87
    
    
    
    3.54
    
    
    
    732,003
    
    
    
    3.51$3.90 - $5.26
    
    
    965,100
    
    
    
    6.94
    
    
    
    4.48
    
    
    
    582,471
    
    
    
    4.61$5.38 - $5.83
    
    
    1,364,197
    
    
    
    6.19
    
    
    
    5.65
    
    
    
    588,197
    
    
    
    5.42$5.88 - $10.75
    
    
    1,129,200
    
    
    
    5.86
    
    
    
    9.32
    
    
    
    935,679
    
    
    
    9.30$12.50
    
    
    5,000
    
    
    
    6.16
    
    
    
    12.50
    
    
    
    5,000
    
    
    
    12.505,533,718
    
    
    
    6.17
    
    
    
    5.02
    
    
    
    3,943,906
    
    
    
    4.81
 As of December 31, 2002 and 2001, options outstanding that were
exercisable were 3,677,142 and 3,457,061, respectively. Reserved Shares As of December 31, 2003, the Company had reserved shares of common stock
for future issuance as follows: Options outstanding
    
    
    5,533,718Shares available for grant
    
    
    1,157,243Warrants outstanding
    
    
    1,004,760Convertible notes payable.
    
    
    1,368,280ESPP
    
    
    509,8849,573,885
 Note 9  401k Plan The Company has a pre-tax savings plan covering substantially all U.S.
employees, which qualifies under Section 401(k) of the Internal Revenue Code.
Under the plan, eligible employees may contribute a portion of their pre-tax
salary, subject to certain limitations. The Company contributes and matches 50%
of the employee contributions, up to 15% of an employees salary. Company
contributions, which can be terminated at the Companys discretion, were
approximately $129,000, $101,000 and $83,000 for the years ended December 31,
2003, 2002 and 2001, respectively. Note 10  Significant Geographic Information The Company operates in one business segment, the development and
commercialization of specialist-oriented proprietary drugs for the treatment of
chronic and life threatening diseases. Currently, the Companys principal focus
has been the development and commercialization of ZADAXIN, the only product
that the Company sells. The Chief Executive Officer has been identified as the Chief Operating
Decision Maker (CODM) because he has final authority over resource allocation
decisions and performance assessment. The CODM does not receive discrete
financial information about the individual components of the business segment. The Companys domestic operations primarily consist of product
development. The Companys wholly owned international subsidiary, SciClone
Pharmaceuticals International Ltd., is based in Hong Kong and is engaged in
sales and marketing and product distribution worldwide. 51




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##### Table of Contents



Information regarding geographic areas is as follows: ContractProduct Sales
    
    Revenue
    
    Longfor the Year
    
    for the Year
    
    LivedEnded
    
    Ended
    
    Assets
    
    Net AssetsDecember 31,
    
    December 31,
    
    December 31,
    
    December 31,2003:U.S.
    
    $
    
    
    
    $
    
    
    
    $
    2,043,000
    
    
    $
    45,093,000China
    
    
    28,078,000
    
    
    
    
    
    
    
    213,000
    
    
    
    22,928,000Other
    
    
    3,654,000
    
    
    
    806,000
    
    
    
    215,000
    
    
    
    229,000Total
    
    $
    31,732,000
    
    
    $
    806,000
    
    
    $
    2,471,000
    
    
    $
    68,250,0002002:U.S.
    
    $
    
    
    
    $
    
    
    
    $
    624,000
    
    
    $
    9,417,000China
    
    
    15,073,000
    
    
    
    
    
    
    
    99,000
    
    
    
    13,728,000Other
    
    
    2,028,000
    
    
    
    671,000
    
    
    
    234,000
    
    
    
    209,000Total
    
    $
    17,101,000
    
    
    $
    671,000
    
    
    $
    957,000
    
    
    $
    23,354,0002001:U.S.
    
    $
    
    
    
    $
    
    
    
    $
    945,000
    
    
    $
    8,407,000China
    
    
    12,325,000
    
    
    
    
    
    
    
    137,000
    
    
    
    13,968,000Other
    
    
    1,506,000
    
    
    
    
    
    
    
    362,000
    
    
    
    399,000Total
    
    $
    13,831,000
    
    
    $
    
    
    
    $
    1,444,000
    
    
    $
    22,774,000
 Two customers accounted for 10% or more of total revenues (52% and 14%)
for the year ended December 31, 2003. Two customers accounted for 10% or more
of total revenues (41% and 27%) for the year ended December 31, 2002. Two
customers accounted for 10% or more of total revenues (47% and 30%) for the
year ended December 31, 2001. No other customer accounted for more than 10% of
revenues during these years. Note 11  Selected Quarterly Financial Data (unaudited) Three Months EndedMarch 31
    
    June 30
    
    September 30
    
    December 312003:Product sales
    
    $
    5,000,000
    
    
    $
    16,207,000
    
    
    $
    5,421,000
    
    
    $
    5,104,000Contract revenue
    
    
    224,000
    
    
    
    224,000
    
    
    
    224,000
    
    
    
    134,000Cost of product sales
    
    
    1,016,000
    
    
    
    2,931,000
    
    
    
    935,000
    
    
    
    754,000Gross margin
    
    
    4,208,000
    
    
    
    13,500,000
    
    
    
    4,710,000
    
    
    
    4,484,000Net income (loss)
    
    
    (2,862,000
    )
    
    
    5,124,000
    
    
    
    (2,850,000
    )
    
    
    (4,687,000
    )Basic net income (loss) per
share
    
    
    (0.08
    )
    
    
    0.14
    
    
    
    (0.07
    )
    
    
    (0.11
    )Diluted net income (loss) per
share
    
    
    (0.08
    )
    
    
    0.13
    
    
    
    (0.07
    )
    
    
    (0.11
    )2002:Product sales
    
    $
    3,948,000
    
    
    $
    4,048,000
    
    
    $
    4,298,000
    
    
    $
    4,807,000Contract revenue
    
    
    
    
    
    
    223,000
    
    
    
    224,000
    
    
    
    224,000Cost of product sales
    
    
    792,000
    
    
    
    815,000
    
    
    
    918,000
    
    
    
    962,000Gross margin
    
    
    3,156,000
    
    
    
    3,457,000
    
    
    
    3,604,000
    
    
    
    4,068,000Net loss
    
    
    (2,403,000
    )
    
    
    (3,345,000
    )
    
    
    (1,672,000
    )
    
    
    (2,617,000
    )Basic and diluted net loss per
share
    
    
    (0.07
    )
    
    
    (0.10
    )
    
    
    (0.05
    )
    
    
    (0.07
    )
 52




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Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable 
 Item 9A.Controls and Procedures (a)Evaluation of Disclosure Controls and Procedures Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial 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, as of December 31, 2003. Based on this evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective as of the end of the period covered by
this annual report. (b)Changes in Internal Control Over Financial Reporting There was no change in our internal control over financial reporting
during our fourth fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting. 53




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PART III 
 Item 10.Directors and Executive Officers of the Registrant The information required by Item 401 of Regulation S-K is incorporated by
reference from the definitive proxy statement for the Companys 2004 Annual
Meeting of Stockholders to be filed with the Commission pursuant to Regulation
14A not later than 120 days after the end of the fiscal year covered by this
Form (the Proxy Statement) under the caption ELECTION OF DIRECTORS 
Nominees, and ELECTION OF DIRECTORS  Board Meetings and Committees  Audit
Committee. Information relating to the executive officers of the Company is
set forth in Part I of this Report under the caption Executive Officers of the
Registrant. The information required by Item 405 of Regulation S-K is incorporated by
reference from the Proxy Statement under the caption EXECUTIVE COMPENSATION
AND OTHER MATTERS  Section 16(a) Beneficial Ownership Reporting Compliance. The information required by Item 406 of Regulation S-K is incorporated by
reference from the Proxy Statement under the caption ELECTION OF DIRECTORS 
Committee Charters and Other Corporate Governance Materials. 
 Item 11.Executive Compensation The information required by this Item is incorporated by reference from
the Proxy Statement under the captions EXECUTIVE COMPENSATION AND OTHER
MATTERS and ELECTION OF DIRECTORS  Compensation of Directors. 
 Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Equity Compensation Plan Information As of December 31, 2003, the Company maintained five compensation plans
that provide for the issuance of common stock to officers and other employees,
directors and consultants. These consist of the 1991 Stock Plan, the 1992
Stock Plan, the 1995 Equity Incentive Plan, the Nonemployee Director Stock
Option Plan and the 1996 Employee Stock Purchase Plan, which plans have all
been approved by the Companys stockholders. The Company does not currently
maintain any compensation plans that have not been approved by the Companys
stockholders. The following table sets forth information regarding outstanding
options and shares reserved for future issuance under the foregoing plans as of
December 31, 2003: Number of shares to
    
    Weighted-
    
    Number of sharesbe issued upon
    
    average exercise
    
    remaining availableexercise of
    
    price of
    
    for future issuanceoutstanding
    
    outstanding
    
    under equity compensationoptions, warrants
    
    options, warrants
    
    plans (excluding sharesand rights
    
    and rights
    
    reflected in column (a))Plan Category
    
    (a)
    
    (b)
    
    (c)Equity compensation plans approved by stockholders:1991 Stock Plan
    
    
    1,356,495
    
    
    $
    4.7996
    
    
    
    1992 Stock Plan
    
    
    87,000
    
    
    $
    5.5199
    
    
    
    1995 Equity Incentive Plan
    
    
    3,512,723
    
    
    $
    4.8358
    
    
    
    992,2431995 Nonemployee Director Stock Option Plan
    
    
    577,500
    
    
    $
    6.6239
    
    
    
    165,0001996 Employee Stock Purchase Plan
    
    
    
    
    
    
    
    
    
    
    509,884
    (1)Total
    
    
    5,533,718
    
    
    $
    5.0243
    
    
    
    1,667,127
 (1) 1996 Employee Stock Purchase Plan is a voluntary plan open to all
employees. This plan allows employees to elect payroll deductions which are
used to purchase SciClones common stock directly from the Company. The information required by Item 403 of Regulation S-K is incorporated by
reference from the Proxy Statement under the caption STOCK OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. 
 Item 13.Certain Relationships and Related Transactions The information required by this Item is incorporated by reference from
the Proxy Statement under the caption EXECUTIVE COMPENSATION AND OTHER MATTERS
 Certain Relationships and Related Transactions. 54




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##### Table of Contents



Item 14. Principal Accountant Fees and Services The information required by this Item is incorporated by reference from
the Proxy Statement under the caption RATIFICATION OF APPOINTMENT OF
INDEPENDENT AUDITORS  Principal Accountant Fees. 
 PART IV 
 Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) The following documents are filed as part of this Report: (1) Financial Statements.The following financial statements of the
Company are contained on pages 36  52 of this Report on Form 10-K: Report of Ernst & Young LLP, Independent Auditors. Consolidated Balance Sheets at December 31, 2003 and 2002. Consolidated Statements of Operations for each of the three years in the
period ended December 31, 2003. Consolidated Statement of Stockholders Equity for the three years ended
December 31, 2003. Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2003. Notes to Consolidated Financial Statements. (2) Financial Statement Schedules The following schedule required to be filed by Item 8 of this form and
Item 15(d) is contained on page 60 of this Report: Schedule II  Valuation and Qualifying Accounts for each of the three
years in the period ended December 31, 2003. All other schedules have been omitted because they are either inapplicable
or the required information has been given in the consolidated financial
statements or the notes thereto. (3) Exhibits. Refer to Item 15(c) below. (b) Reports on Form 8-K. We filed one Current Report on Form 8-K during the last quarter of the
period covered by this report. The Current Report was dated October 27, 2003
and was furnished pursuant to Item 7 and Item 12. 55




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##### Table of Contents



(c) Exhibits. Exhibits (numbered in accordance with Item 601 of Regulation S-K): ExhibitNumber
    
    Description3(i).1(1)
    
    Amended and Restated Certificate of Incorporation.3(ii).1(1)
    
    Bylaws.4.1(9)
    
    Rights Agreement dated as of July 25, 1997 between the Registrant and Chase Mellon Shareholder
Services, LLC4.2(1)
    
    First Amendment to Rights Agreement dated as of July 17, 2003 between the Registrant and Mellon
Investor Services LLC.4.3(13)*
    
    6% Convertible Note dated as of December 7, 2000 by the Registrant in favor of UBS AG, London Branch.4.4(13)*
    
    Option Agreement dated as of October 26, 2000 by and between the Registrant and UBS AG, London Branch.4.5(13)*
    
    Amendment No. 1 to Option Agreement dated as of December 19, 2000 by and between the Registrant and
UBS AG, London Branch.4.6(14)*
    
    6% Convertible Note dated as of March 21, 2001 by the Company in favor of UBS AG, London Branch.4.7(14)*
    
    Option Agreement dated as of February 16, 2001 by and between the Company and UBS AG, London Branch.4.8(14)*
    
    Amendment No. 1 to Option Agreement dated as of March 21, 2001 by and between the Company and UBS AG,
London Branch.10.1(3)**
    
    Registrants 1991 Stock Plan, together with forms of agreements thereunder.10.2(2)**
    
    Registrants 1992 Stock Plan, together with forms of agreements thereunder.10.3(5)**
    
    Registrants 1995 Equity Incentive Plan, together with forms of agreement thereunder.10.4(5)**
    
    Registrants 1995 Nonemployee Director Stock Option Plan, together with forms of agreement thereunder.10.5(17)**
    
    Registrants 1996 Employee Stock Purchase Plan, as amended.10.6(2)
    
    Lease, dated September 10, 1991, between the Registrant and Spieker-Singleton68 concerning property,
located at 901 Mariners Island Boulevard, San Mateo, California, as amended (the Spieker Lease).10.7(4)
    
    Amendment No. 4 to Spieker Lease, dated October 4, 1994.10.8(6)
    
    Amendment No. 7 to Spieker Lease, dated November 14, 1995.10.9(8)
    
    Amendment No. 8 to Spieker Lease, dated August 26, 1996.10.10(13)
    
    Amendment No. 14 to Spieker Lease dated November 21, 2000.10.11(19)
    
    Employment Agreement, effective as of February 1, 1996, between the Registrant and Donald R. Sellers.10.12(19)
    
    Fifth Amendment of Employment Agreement, effective as of November 30, 2003, between the Registrant
and Donald R. Sellers.10.13(13)
    
    Change in Control Agreement between the Company and Alfred Rudolph dated as of November 19, 1999.10.14(13)
    
    Change in Control Agreement between the Company and Donald R. Sellers dated as of November 19, 1999.10.15(15)
    
    Change in Control Agreement between the Company and Richard A. Waldron dated as of April 30, 2001.10.16(17)
    
    Change in Control Agreement between the Company and Hans P. Schmid dated as of April 22, 2003.10.17(18)
    
    Form of Indemnity Agreement by and between the Registrant and each director and executive officer of
SciClone Pharmaceuticals, Inc.10.18(7)*
    
    License Agreement effective April 19, 1996 between the Registrant and the National Institute of
Health Office of Technology Transfer.10.19(10)
    
    Alpha Rights Acquisition Agreement by and between the Registrant and Alpha 1 Biomedicals, Inc., dated
December 17, 1997.10.20(11)*
    
    Expanded and Amended Thymosin Alpha 1 License, Distributorship and Supply Agreement by and between
the Company and Sigma-Tau Industrie Farmadeutiche Riunite S.p.A. dated as of March 3, 2000.10.21(16)*
    
    Amendment No. 1 to the Expanded and Amended Thymosin Alpha 1 License, Distributorship and Supply
Agreement by and between the Company and Sigma-Tau Farmadeutiche Riunite S.p.A. dated as of December
19, 2001.
 56




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##### Table of Contents



ExhibitNumber
    
    Description10.22(12)
    
    Acquisition Agreement between the Company and Sclavo S.p.A. dated April 20,1998.10.23(12)
    
    First Amendment to Acquisition Agreement between the Company and Sclavo S.p.A., dated April 20, 1998.10.24(14)*
    
    Registration Rights Agreement by and between the Company and UBS AG, London Branch dated as of
February 16, 2001.10.25(16)*
    
    Common Stock Purchase Agreement between the Company and each of Defiante Farmaceutica Ld.A. and
Aptafin S.p.A. dated as of January 21, 2003.10.26(19)*
    
    Manufacturing and Supply Agreement between SciClone Pharmaceuticals International Ltd. and Patheon
Italia S.p.A. dated as of November 1, 2002.21.1(15)
    
    Subsidiaries of Registrant.23.1(19)
    
    Consent of Ernst & Young LLP, Independent Auditors.24.1(19)
    
    Powers of Attorney. See page 59.31.1(19)
    
    Rule 13a-14(a) Certification of Chief Executive Officer.31.2(19)
    
    Rule 13a-14(a) Certification of Chief Financial Officer.32.1(19)
    
    Section 1350 Certification of Chief Executive Officer.32.2(19)
    
    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.**
    
    Management compensatory plan or arrangement.  (1)
    
    Incorporated by reference from the Companys Current Report on 8-K filed
on July 28, 2003.(2)
    
    Incorporated by reference from the Companys Registration Statement on
Form S-l (No. 33-45446), declared effective by the Commission on March 17,
1992.(3)
    
    Incorporated by reference from the Companys Registration Statement on
Form S-8 (No. 33-66832) filed with the Commission on August 3, 1993.(4)
    
    Incorporated by reference from the Companys Annual Report on Form 10-K
for the year ended December 31, 1994.(5)
    
    Incorporated by reference from the Companys Registration Statement on
Form S-8 (No. 33-80911) filed with the Commission on December 28, 1995.(6)
    
    Incorporated by reference from the Companys Annual Report on Form 10-K
for the year ended December 31, 1995.(7)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1996.(8)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1996.(9)
    
    Incorporated by reference from the Companys Current Report on Form 8-K
filed on October 14, 1997.(10)
    
    Incorporated by reference from the Companys Current Report on Form 8-K
filed on January 26, 1998.(11)
    
    Incorporated by reference from the Companys Form 8-K filed on April 20,
2000.(12)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1998.(13)
    
    Incorporated by reference from the Companys Annual Report on Form 10-K
for the year ended December 31, 2000. 57




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##### Table of Contents



(14)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2001.(15)
    
    Incorporated by reference from the Companys Annual Report on Form
10-K for the year ended December 31, 2001.(16)
    
    Incorporated by reference from the Companys Annual Report on Form
10-K for the year ended December 31, 2002.(17)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2003.(18)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended September 30, 2003.(19)
    
    Filed herewith. 58




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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.By:
    
    /s/
    
    Donald R. SellersDonald R. SellersPresident and Chief Executive OfficerDate: March 15, 2004
 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Donald R. Sellers and Richard A.
Waldron, and each of them, his attorneys-in-fact and agents, each with the
power of substitution and resubstitution, for him in any and all capacities, to
sign this Report on Form 10-K, and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, granting to said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary, to be done in connection therewith, as fully as to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or either of them, or
their or his substitute or substitutes, may do or cause to be done by virtue
hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/
    
    Donald R. Sellers
    
    President and Chief Executive Officer, Director
    
    March 15, 2004(Donald R. Sellers)
    
    Principal Executive Officer/s/
    
    Richard A. Waldron
    
    Chief Financial Officer
    
    March 15, 2004(Richard A. Waldron)
    
    Principal Financial Officer/s/
    
    Ivan B. Hui
    
    Director, Finance
    
    March 15, 2004(Ivan B. Hui)
    
    Principal Accounting Officer/s/
    
    John D. Baxter, M.D.
    
    Director
    
    March 15, 2004(John D. Baxter, M.D.)/s/
    
    Edwin C. Cadman, M.D.
    
    Director
    
    March 15, 2004(Edwin C. Cadman, M.D.)/s/
    
    Jere E. Goyan, Ph.D.
    
    Chairman of Board of Directors
    
    March 15, 2004(Jere E. Goyan, Ph.D.)/s/
    
    Rolf H. Henel
    
    Director
    
    March 15, 2004(Rolf H. Henel)/s/
    
    Jon S. Saxe
    
    Director
    
    March 15, 2004(Jon S. Saxe)/s/
    
    Dean S. Woodman
    
    Director
    
    March 15, 2004(Dean S. Woodman)
 59




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##### Table of Contents



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS SCICLONE PHARMACEUTICALS INC. Balance at
    
    Charged toBeginning of
    
    Costs and
    
    
    
    
    
    Balance atDescription
    
    Period
    
    Expenses
    
    Deductions
    
    End of PeriodYear Ended December 31, 2003Reserves and allowances deducted from asset accounts:Allowance for uncollectable accounts
    
    $
    638,000
    
    
    $
    
    
    
    $
    
    
    
    $
    638,000Inventory reserve
    
    $
    190,000
    
    
    $
    420,000
    
    
    $
    
    
    
    $
    610,000Year Ended December 31, 2002Reserves and allowances deducted from asset accounts:Allowance for uncollectable accounts
    
    $
    638,000
    
    
    $
    
    
    
    $
    
    
    
    $
    638,000Inventory reserve
    
    $
    400,000
    
    
    $
    
    
    
    $
    210,000
    
    
    $
    190,000Year Ended December 31, 2001Reserves and allowances deducted from asset accounts:Allowance for uncollectable accounts
    
    $
    394,000
    
    
    $
    244,000
    
    
    $
    
    
    
    $
    638,000Inventory reserve
    
    $
    230,000
    
    
    $
    170,000
    
    
    $
    
    
    
    $
    400,000
 60




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##### Table of Contents



INDEX TO EXHIBITS ExhibitNumber
    
    Exhibit3(i).1(1)
    
    Amended and Restated Certificate of Incorporation.3(ii).1(1)
    
    Bylaws.4.1(9)
    
    Rights Agreement dated as of July 25, 1997 between the Registrant and Chase Mellon
Shareholder Services, LLC4.2(1)
    
    First Amendment to Rights Agreement dated as of July 17, 2003 between the Registrant
and Mellon Investor Services LLC.4.3(13)*
    
    6% Convertible Note dated as of December 7, 2000 by the Registrant in favor of UBS
AG, London Branch.4.4(13)*
    
    Option Agreement dated as of October 26, 2000 by and between the Registrant and UBS
AG, London Branch.4.5(13)*
    
    Amendment No. 1 to Option Agreement dated as of December 19, 2000 by and between the
Registrant and UBS AG, London Branch.4.6(14)*
    
    6% Convertible Note dated as of March 21, 2001 by the Company in favor of UBS AG,
London Branch.4.7(14)*
    
    Option Agreement dated as of February 16, 2001 by and between the Company and UBS
AG, London Branch.4.8(14)*
    
    Amendment No. 1 to Option Agreement dated as of March 21, 2001 by and between the
Company and UBS AG, London Branch.10.1(3)**
    
    Registrants 1991 Stock Plan, together with forms of agreements thereunder.10.2(2)**
    
    Registrants 1992 Stock Plan, together with forms of agreements thereunder.10.3(5)**
    
    Registrants 1995 Equity Incentive Plan, together with forms of agreement thereunder.10.4(5)**
    
    Registrants 1995 Nonemployee Director Stock Option Plan, together with forms of
agreement thereunder.10.5(17)**
    
    Registrants 1996 Employee Stock Purchase Plan, as amended.10.6(2)
    
    Lease, dated September 10, 1991, between the Registrant and Spieker-Singleton68
concerning property, located at 901 Mariners Island Boulevard, San Mateo,
California, as amended (the Spieker Lease).10.7(4)
    
    Amendment No. 4 to Spieker Lease, dated October 4, 1994.10.8(6)
    
    Amendment No. 7 to Spieker Lease, dated November 14, 1995.10.9(8)
    
    Amendment No. 8 to Spieker Lease, dated August 26, 1996.10.10(13)
    
    Amendment No. 14 to Spieker Lease dated November 21, 2000.10.11(19)
    
    Employment Agreement, effective as of February 1, 1996, between the Registrant and
Donald R. Sellers.10.12(19)
    
    Fifth Amendment of Employment Agreement, effective as of November 30, 2003, between
the Registrant and Donald R. Sellers.10.13(13)
    
    Change in Control Agreement between the Company and Alfred Rudolph dated as of
November 19, 1999.10.14(13)
    
    Change in Control Agreement between the Company and Donald R. Sellers dated as of
November 19, 1999.10.15(15)
    
    Change in Control Agreement between the Company and Richard A. Waldron dated as of
April 30, 2001.10.16(17)
    
    Change in Control Agreement between the Company and Hans P. Schmid dated as of April
22, 2003.
 61




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##### Table of Contents



ExhibitNumber
    
    Exhibit10.17(18)
    
    Form of Indemnity Agreement by and between the Registrant and each director and
executive officer of SciClone Pharmaceuticals, Inc.10.18(7)*
    
    License Agreement effective April 19, 1996 between the Registrant and the National
Institute of Health Office of Technology Transfer.10.19(10)
    
    Alpha Rights Acquisition Agreement by and between the Registrant and Alpha 1
Biomedicals, Inc., dated December 17, 1997.10.20(11)*
    
    Expanded and Amended Thymosin Alpha 1 License, Distributorship and Supply Agreement
by and between the Company and Sigma-Tau Industrie Farmadeutiche Riunite S.p.A.
dated as of March 3, 2000.10.21(16)*
    
    Amendment No. 1 to the Expanded and Amended Thymosin Alpha 1 License,
Distributorship and Supply Agreement by and between the Company and Sigma-Tau
Farmadeutiche Riunite S.p.A. dated as of December 19, 2001.10.22(12)
    
    Acquisition Agreement between the Company and Sclavo S.p.A. dated April 20,1998.10.23(12)
    
    First Amendment to Acquisition Agreement between the Company and Sclavo S.p.A.,
dated April 20, 1998.10.24(14)*
    
    Registration Rights Agreement by and between the Company and UBS AG, London Branch
dated as of February 16, 2001.10.25(16)*
    
    Common Stock Purchase Agreement between the Company and each of Defiante
Farmaceutica Ld.A. and Aptafin S.p.A. dated as of January 21, 2003.10.26(19)*
    
    Manufacturing and Supply Agreement between SciClone Pharmaceuticals International
Ltd. and Patheon Italia S.p.A. dated as of November 1, 2002.21.1(15)
    
    Subsidiaries of Registrant.23.1(19)
    
    Consent of Ernst & Young LLP, Independent Auditors.24.1(19)
    
    Powers of Attorney. See page 59.31.1(19)
    
    Rule 13a-14(a) Certification of Chief Executive Officer.31.2(19)
    
    Rule 13a-14(a) Certification of Chief Financial Officer.32.1(19)
    
    Section 1350 Certification of Chief Executive Officer.32.2(19)
    
    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.**
    
    Management compensatory plan or arrangement.  (1)
    
    Incorporated by reference from the Companys Current Report on 8-K filed
on July 28, 2003.(2)
    
    Incorporated by reference from the Companys Registration Statement on
Form S-l (No. 33-45446), declared effective by the Commission on March 17,
1992.(3)
    
    Incorporated by reference from the Companys Registration Statement on
Form S-8 (No. 33-66832) filed with the Commission on August 3, 1993.(4)
    
    Incorporated by reference from the Companys Annual Report on Form 10-K
for the year ended December 31, 1994.(5)
    
    Incorporated by reference from the Companys Registration Statement on
Form S-8 (No. 33-80911) filed with the Commission on December 28, 1995.(6)
    
    Incorporated by reference from the Companys Annual Report on Form 10-K
for the year ended December 31, 1995. 62




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##### Table of Contents



(7)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1996.(8)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1996.(9)
    
    Incorporated by reference from the Companys Current Report on Form 8-K
filed on October 14, 1997.(10)
    
    Incorporated by reference from the Companys Current Report on Form 8-K
filed on January 26, 1998.(11)
    
    Incorporated by reference from the Companys Form 8-K filed on April 20,
2000.(12)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1998.(13)
    
    Incorporated by reference from the Companys Annual Report on Form 10-K
for the year ended December 31, 2000.(14)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2001.(15)
    
    Incorporated by reference from the Companys Annual Report on Form
10-K for the year ended December 31, 2001.(16)
    
    Incorporated by reference from the Companys Annual Report on Form
10-K for the year ended December 31, 2002.(17)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2003.(18)
    
    Incorporated by reference from the Companys Quarterly Report on Form
10-Q for the quarterly period ended September 30, 2003.(19)
    
    Filed herewith. 63