Sciclone Pharmaceuticals 10Q 2002 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X]

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

For the quarterly period ended March 31, 2002

[ ]

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)


California		94-3116852

(State or other jurisdiction of incorporation or organization)		(I.R.S. employer Identification no.)

901 Mariner’s Island Blvd., Suite 205, San Mateo, California		94404

(Address of principal executive offices)		(Zip code)

(650) 358-3456

(Registrant’s telephone number, including area code)

Not Applicable

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

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

Yes [X] No [ ]

As of March 31, 2002, 32,717,475 shares of the registrant’s Common Stock, no par value, were issued and outstanding.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	Item 1. Condensed Consolidated Financial Statements
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		Notes to Condensed Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk.
PART II. OTHER INFORMATION
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES

SCICLONE PHARMACEUTICALS, INC.

INDEX


PART I	FINANCIAL INFORMATION	PAGE NO.

Item 1.	Condensed Consolidated Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001	3

	Condensed Consolidated Statements of Operations for the Three-month periods ended March 31, 2002 and 2001	4

	Condensed Consolidated Statements of Cash Flows for the Three-month periods ended March 31, 2002 and 2001	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29

PART II	OTHER INFORMATION

Item 6.	Exhibits and Reports on Form 8-K	30

Signatures		31

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

SCICLONE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS


		March 31,			December 31,
		2002			2001

		(unaudited)			(Note 1)
Current assets:
	Cash and cash equivalents	$	15,532,000		$	15,518,000
	Restricted short-term investments		633,000			633,000
	Other short-term investments		360,000			317,000
	Accounts receivable, net		9,336,000			8,792,000
	Inventories		4,310,000			4,059,000
	Prepaid expenses and other current assets		1,155,000			1,333,000

Total current assets			31,326,000			30,652,000
Property and equipment, net			166,000			167,000
Intangible assets, net			990,000			1,091,000
Other assets			179,000			186,000

Total assets		$	32,661,000		$	32,096,000


LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
	Accounts payable	$	1,673,000		$	1,575,000
	Accrued compensation and employee benefits		538,000			960,000
	Accrued clinical trials expense		441,000			296,000
	Accrued professional fees		583,000			633,000
	Deferred revenue		895,000			—
	Other accrued expenses		262,000			258,000
Total current liabilities			4,392,000			3,722,000
Deferred revenue			1,790,000			—
Convertible notes payable			5,600,000			5,600,000
Shareholders’ equity:
	Common stock, no par value; 75,000,000 shares authorized; 32,717,475 and 32,474,150 shares issued and outstanding at March 31, 2002 and December 31, 2001, respectively		146,184,000			145,713,000
	Accumulated other comprehensive income		76,000			39,000
	Accumulated deficit		(125,381,000	)		(122,978,000	)
Total shareholders’ equity			20,879,000			22,774,000

Total liabilities and shareholders’ equity		$	32,661,000		$	32,096,000

See notes to condensed consolidated financial statements

SCICLONE PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)


		Three months ended
		March 31,

		2002			2001

Product sales		$	3,948,000		$	3,113,000
Cost of product sales			792,000			598,000

Gross margin			3,156,000			2,515,000
Operating expenses:
	Research and development		2,526,000			1,741,000
	Sales and marketing		2,008,000			2,090,000
	General and administrative		992,000			1,017,000

Total operating expenses			5,526,000			4,848,000

Loss from operations			(2,370,000	)		(2,333,000	)
Interest and investment income			76,000			264,000
Interest and investment expense			(90,000	)		(63,000	)
Other income (expense), net			(19,000	)		7,000

Net loss		$	(2,403,000	)	$	(2,125,000	)

Basic and diluted net loss per share		$	(0.07	)	$	(0.07	)

Weighted average shares used in computing basic and diluted net loss per share			32,583,558			32,242,093

See notes to condensed consolidated financial statements

SCICLONE PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)


			Three months ended
			March 31,

			2002			2001

Operating activities:
Net loss			$	(2,403,000	)	$	(2,125,000	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization			146,000			126,000
	Changes in operating assets and liabilities:
		Prepaid expenses and other current assets		178,000			(312,000	)
		Accounts receivable, net		(544,000	)		(175,000	)
		Inventories		(251,000	)		59,000
		Accounts payable and other accrued expenses		102,000			(1,029,000	)
		Accrued compensation and employee benefits		(422,000	)		(387,000	)
		Accrued clinical trials expense		145,000			48,000
		Accrued professional fees		(50,000	)		296,000
		Deferred revenue		2,685,000			—

Net cash used in operating activities				(414,000	)		(3,499,000	)

Investing activities:
	Purchase of property and equipment			(36,000	)		(18,000	)
	Payment on purchase of marketable securities			(7,000	)		(313,000	)

Net cash used in investing activities				(43,000	)		(331,000	)

Financing activities:
	Proceeds from issuance of convertible note			—			1,600,000
	Proceeds from issuance of common stock, net of financing costs			471,000			465,000

Net cash provided by financing activities				471,000			2,065,000

Net increase (decrease) in cash and cash equivalents				14,000			(1,765,000	)
Cash and cash equivalents, beginning of period				15,518,000			21,981,000

Cash and cash equivalents, end of period			$	15,532,000		$	20,216,000

See notes to condensed consolidated financial statements

SCICLONE PHARMACEUTICALS, INC.

Notes to Condensed Consolidated Financial Statements
(unaudited)

1.		The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles consistent with those applied in, and should be read in conjunction with, the audited financial statements for the year ended December 31, 2001. The interim financial information reflects all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The balance sheet data at December 31, 2001 is derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Certain prior year amounts have been reclassified to conform to the current quarter presentation. The interim results are not necessarily indicative of results for subsequent interim periods or for the full year.

2.		The Company recognizes revenue from product sales at the time of shipment and recognizes contract/grant revenue when services have been performed. 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 upon the achievement of the milestones, as defined in the respective agreements. Revenue under research and development cost reimbursement contracts is recognized as the related costs are incurred.

3.		For the three-month periods ended March 31, 2002 and 2001, the Company’s total comprehensive loss amounted to $(2,365,000) and $(2,112,000), respectively.

The following is a summary of available-for sale securities at March 31, 2002 and December 31, 2001:


				Gross		Estimated
		Amortized		Unrealized		Fair
		Cost		Gains		Value

March 31, 2002:
	Certificate of deposit	$	867,000	$	—	$	867,000
	Corporate obligations		12,167,000		2,000		12,169,000
	Corporate equity securities		51,000		75,000		126,000

		$	13,085,000	$	77,000	$	13,162,000

December 31, 2001:
	Certificate of deposit	$	865,000	$	—	$	865,000
	Corporate obligations		10,858,000		6,000		10,864,000
	Corporate equity securities		51,000		33,000		84,000

		$	11,774,000	$	39,000	$	11,813,000

		As of March 31, 2002, the total available-for-sale securities are included as follows, $12,169,000 in cash and cash equivalents, $633,000, in restricted short-term investments and $360,000 in other short-term investments.

5.		The following is a summary of inventories at March 31, 2002 and December 31, 2001:


	March 31,			December 31,
	2002			2001

Raw materials	$	2,955,000		$	2,759,000
Work in progress		1,158,000			1,269,000
Finished goods		452,000			431,000
Reserve		(255,000	)		(400,000	)

	$	4,310,000		$	4,059,000

The following is a summary of intangible assets at March 31, 2002 and December 31, 2001:


	March 31,			December 31,
	2002			2001

Intangible product rights	$	2,456,000		$	2,456,000
Accumulated amortization		(1,466,000	)		(1,365,000	)

	$	990,000		$	1,091,000

ZADAXIN® product rights that the Company acquired are being amortized over six years beginning in September 1998. Amortization expense for the three months ended March 31, 2002 and 2001 was $101,000. Amortization expense for the years ended December 31, 2002, 2003 and 2004 is expected to be $409,000, $409,000 and $273,000,

		respectively. The Company reassesses the useful life of these assets in accordance with current facts and circumstances. Further, the Company identifies and records impairment losses, as circumstances dictate, 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 changes in useful life or impairment losses on these assets.

7.		For the three-month period ended March 31, 2002, the Company received approximately $442,000 in connection with exercises of outstanding options to purchase 231,502 shares of common stock.

8.		The Company does not have any minimum purchase requirements under its contract manufacturing supply agreements for ZADAXIN and CPX.

9.		Net loss per share is computed using the weighted average number of shares of common stock outstanding. Common equivalent shares from stock options and warrants are excluded, as their effect is antidilutive.

10.		The Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on January 1, 2002. There has been no impact on the Company’s operating results from the adoption of this standard.

11.		In January 2002, we received $2,685,000 from our European partner Sigma Tau under the terms of our collaborative agreement announced in late December 2001. This receipt has been recorded as deferred revenue and will be recognized as contract revenue starting in April 2002 over the next three years.

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

Special Note Regarding Forward-Looking Statements

This Report 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 industry, management’s beliefs and certain assumptions made by us. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes” or similar expressions are intended to identify forward-looking statements and our forward looking statements include those statements we make regarding the timing and outcome of clinical trials, anticipated sales and research and development expense levels. 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” on this Form 10-Q. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Overview

SciClone Pharmaceuticals, Inc. (“SciClone” or the “Company”) develops and commercializes pharmaceutical and biological therapeutic compounds that are acquired or in-licensed at the stage of late pre-clinical or early clinical development. SciClone’s strategic goal, based on the broad therapeutic potential of its lead drug ZADAXIN, is to become the preeminent worldwide provider of immune system enhancers, or ISEs, as monotherapies and as critical components of combination drug therapies for infectious diseases and cancer. ZADAXIN has been approved for sale primarily as a monotherapy for hepatitis B, in 27 countries with additional approvals anticipated and has been administered without clinically significant side effects to patients for over 10 years. Currently, SciClone is targeting major market regulatory approval for ZADAXIN by focusing on its U.S. hepatitis C phase 3 clinical trials, Japanese hepatitis B phase 3 clinical trial and European cancer phase 2-3 clinical trials in collaboration with SciClone’s European partner, Sigma-Tau, S.p.A.

ZADAXIN is a synthetic preparation of a natural peptide, thymosin alpha 1, that enhances the body’s Th1 (T-helper cell 1) immune response. There are no reports of significant side effects in more than 10,000 patients to date, in both clinical trial and commercial use for several different diseases, including viral diseases (hepatitis C and B) and cancers (hepatocellular carcinoma and malignant melanoma). This safety profile, combined with its unique mechanism of action, ideally positions ZADAXIN as the immune system enhancer of choice for use in combination therapies for infectious diseases and cancer. Other drugs in SciClone’s pipeline are intended to protect and expand this franchise, and to address the protein-based disorder that causes cystic fibrosis.

While SciClone has obtained ZADAXIN marketing approvals in 27 countries overseas, the Company’s current clinical development strategy is to focus on hepatitis C as the first indication for commercial registration of ZADAXIN in the U.S. In Europe, SciClone’s

collaboration partner Sigma-Tau plans to pursue regulatory approval for ZADAXIN for oncology indications with a phase 2 and 3 clinical program, initially focused on malignant melanoma. In addition, Sigma-Tau will pursue regulatory approval in Europe for ZADAXIN as a therapy for hepatitis C using data from SciClone’s phase 3 clinical trials in the U.S. SciClone is also developing ZADAXIN for use as a therapy for hepatitis B in Japan and also intends to file hepatitis C data in that market after the U.S. trial is completed. SciClone produces ZADAXIN for current commercial sales through contract manufacturers in Western Europe. Most of the Company’s current sales are to importing agents in the People’s Republic of China for distribution in that country. In the U.S., SciClone anticipates moving toward entering into a marketing collaboration in the later stages of its phase 3 clinical trials when the Company believes the product should have enhanced partnering value, though there is no assurance such a partnering arrangement can be successfully achieved.

ZADAXIN

ZADAXIN, an immune system enhancer, is a synthetic preparation of thymosin alpha 1, an immune system peptide that occurs naturally and whose activities increasingly are being recognized to regulate the body’s immune response to viral infection or malignancy. Published scientific and clinical studies have shown that ZADAXIN’s activities include helping to stimulate, maintain and direct the body’s antiviral and anticancer immune response — to both target the intended affected cells and to enhance the immune system’s capabilities for cell-specific eradication.

Disease-causing agents which remain circulating in the blood usually are quickly recognized and eliminated by the body’s humoral, or antibody-based, immune component. ZADAXIN’s critical role in the immune response is played out in the more complicated realm of cellular immunity, when certain of the body’s own cells need to be the target of an immune response because of infection or malignancy, even though the immune system does not recognize these cells as foreign. Diseases requiring a cellular immune response, such as HIV, hepatitis C and cancer, have generally been the most resistant to therapeutic intervention to date, and remain at the frontier of current medical investigation.

Humoral and cellular immune response to some degree “cross-regulate” each other, with cytokine production determining which holds precedence. ZADAXIN seems to be an important regulator of these responses. Increasingly, studies have suggested that ZADAXIN enhances the maturation of stem cells and their differentiation into mature CD4, CD8, T and natural killer cells. ZADAXIN increases the Th1 subset of CD4 cells (which favors cellular immunity) by increasing the production of cytokines such as IL-2 and gamma interferon. ZADAXIN also enhances the expression of class I MHC molecules on diseased human cells, which leads to increased recognition and their destruction by CD8 cells.

Studies also have demonstrated that hepatitis C is able to evade the body’s immune response leading to chronic viral infection if the body’s immune response is “switched” to the Th2 mode. A Th1 response, on the other hand, is fundamental to hepatitis C eradication. Current treatments for hepatitis C, such as alpha interferon, although showing a degree of efficacy, actually induce a counter-regulatory increase in Th2 cytokine production. The addition of ZADAXIN to alpha interferon counterbalances this Th2 cytokine production process and

amplifies Th1 cytokine production thereby presenting the promise of an enhanced combination therapy. There are no reports that ZADAXIN, either as a monotherapy or as a component in combination therapy with other drugs, has produced any serious, adverse side effects in more than 3,000 patients in various clinical trials to date and in thousands more in commercial use, thereby suggesting that ZADAXIN should not add to the toxicity profile of a multi-drug hepatitis C regimen.

SciClone’s proprietary position for ZADAXIN is protected by patents in the U.S., Europe, Japan and various other countries, either alone or in combination with a variety of other drugs, for its use as a treatment for hepatitis C, hepatitis B and for certain cancers. For use as a treatment for hepatitis C, patent coverage extends to 2015 in the U.S. and to 2012 in the European Union and in Japan.

Hepatitis C (HCV)

The Centers for Disease Control estimate that up to 4 million people in the U.S. are infected by HCV and no vaccine for it has been developed. There are approximately 40,000 new cases each year. While only 30 percent of those infected are initially symptomatic, in approximately 85 percent the infection becomes chronic, and some 70 percent suffer from complications of chronic liver disease. HCV currently causes 8,000 to 10,000 deaths per year in the U.S. These numbers are expected to triple by 2010. There are at least six different genotypes, or “strains”, of HCV and over 100 sub-genotypes. Genotype 1 is the most difficult to treat and is the most common variant in the U.S., infecting approximately 75 percent of all patients.

Current year-long treatment regimens can cost more than $17,000 per patient in the U.S., with the total therapeutic market in the U.S. and Europe estimated to be well over $2 billion and expected to grow to $4-5 billion by 2004. Alpha interferon is the backbone of treatment, predominantly used in combination with the antiviral ribavirin (the combination treatment is marketed by Schering-Plough under the tradename “Rebetron™”). Alpha interferon can induce relatively severe toxicity, and ribavirin introduces additional serious toxicities of its own. Many patients cannot, or will not, tolerate a full-year regimen of alpha interferon and ribavirin. More recently, longer acting forms of alpha interferon, pegylated alpha interferon, have been developed by Schering-Plough and by F. Hoffmann La-Roche under the tradenames “Peg-Intron™” and “Pegasys™”, respectively. Alpha interferon in its pegylated form allows alpha interferon to stay in the bloodstream longer permitting less frequent injections and more consistent viral suppression. However, the combination of pegylated alpha interferon plus ribavirin is effective in achieving a sustained elimination of the hepatitis C virus in only about 50 percent of naïve, that is, first time treated, patients and the treatment side effect profile remains severe. Moreover, the effectiveness of current therapy is highly dependent on the genotype of the infecting virus and the viral load, or level of virus present in the patient. For genotype 1 patients with a high viral load, which characterizes about half of all HCV patients in the U.S., current therapy is effective in only about 30 percent of the cases. Patients that fail to respond to therapy seldom respond to a second 12-month regimen of the same treatment. The success rate for treating non-responders with non-pegylated alpha interferon plus ribavirin is only approximately 8 percent. In early clinical studies, the combination of ZADAXIN and alpha interferon, when used to treat non-responders, achieved a 22 percent response rate. We believe that this improvement is clinically significant and have designed and implemented our U.S. phase 3 hepatitis C clinical program based on these data.

ZADAXIN, we believe, represents the closest new opportunity for improving the treatment for hepatitis C patients in the foreseeable future. Based upon our review of the market, virtually nothing else is on the horizon in a similar advanced clinical stage of development. We redesigned and timed the implementation of our phase 3 U.S. clinical program of ZADAXIN to use it in combination with the newest form of interferon, pegylated alpha interferon.

Clinical Development Strategy

Our clinical development strategy for ZADAXIN in the U.S. has been to select an indication where ZADAXIN may add the greatest efficacy compared to current standard treatment, where the likelihood of expedited review is greatest due to a lack of an approved treatment, where the initial patient population supports the greatest financial return upon successful registration and where SciClone has a strong intellectual property position for the use of ZADAXIN. Results from clinical trials suggest that using ZADAXIN with interferon produces better results than using interferon independently or interferon with ribavirin for the treatment of hepatitis C in primary non-responders. Thus, we have focused our phase 3 clinical trials on hepatitis C non-responders (no virological response at the end of a standard course of therapy) to interferon or to interferon plus ribavirin.

Non-responders typically have high viral loads of HCV genotype 1, which is also characteristic of half of all HCV patients in the U.S. We estimate that there are approximately 200,000 patients in the U.S. alone who have failed to respond to treatment using interferon independently or interferon in combination with ribavirin and that this patient group will grow to approximately 500,000 identifiable non-responders by 2005. Non-responders are a commercially attractive initial target market for ZADAXIN. Such patients generally are motivated to seek treatment, are already identified by their physicians, are in the health care and insurance systems, and their number is growing as more new patients seek and ultimately fail first-time therapy for HCV.

The phase 3 U.S. clinical trials consist of two 500-patient, multicenter, randomized, double-blinded studies, and the trials are designed to provide the data and safeguards required to file a successful marketing application if the data demonstrate clinical benefit. Patients in equal numbers are being assigned to a one-year course of ZADAXIN plus pegylated interferon or to a course of pegylated interferon plus placebo. Primary endpoints are a sustained virological response and an improvement in the liver histological activity index measured six months after the end of the 12-month therapy, consistent with the U.S. Food and Drug Administration, or the FDA, standard for demonstrating sustained response to HCV therapy. Efficacy data at the end of the 12-month treatment period will be included as a secondary endpoint of the trial.

The Pegasys brand of pegylated interferon for both trials is being provided at no cost to us by F. Hoffmann La-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. The costs of this U.S. study are also supported, without any U.S. marketing rights, by our European partner, Sigma-Tau. In early 2002 Sigma-Tau contributed $2.7 million and will make an additional $1 million milestone payment when the 1,000 patients are recruited in our U.S. clinical trials. Patient enrollment began in the early part of the second quarter of 2002. Under this plan the

treatment and observation periods for the first patients would be completed by the end of 2003 and for all patients in the phase 3 clinical trials by mid-2004, though there is no assurance that patients can be recruited to plan.

We believe that oncology will be another large market opportunity for ZADAXIN as the immune system enhancer of choice in certain cancer multi-drug treatments. ZADAXIN’s mechanism of action stimulates and directs the body’s immune response toward many forms of malignant cells. In addition, use of ZADAXIN has not demonstrated any serious, adverse side effects in combination with many known anticancer drugs. In comparison, most anticancer drugs are normally highly toxic which complicates the efficacy of many combination treatments often raising prohibitive safety issues and hindering patient compliance.

Our clinical strategy in oncology is to implement a broad phase 2 clinical program with leading cancer investigators in the U.S. and Europe concurrent with the phase 3 HCV clinical and registration program. We intend to generate a substantial body of published phase 2 data in specific cancers where ZADAXIN has shown preclinical or early clinical potential as a component of therapy in order to determine the feasibility and design of pivotal phase 3 trials in oncology. We are currently sponsoring two phase 2 U.S. trials for liver cancer, which is a common result of untreated or progressive hepatitis C or hepatitis B. ZADAXIN is being combined with transarterial chemoembolization (TACE) or with radio frequency ablation (RFA), the two most common procedures for hepatocellular carcinoma (HCC) patients whose tumors cannot be treated either by surgery or by liver transplantation. The studies are designed to duplicate the survival benefits that were demonstrated in our European phase 2 HCC studies. HCC accounts for more than 80 percent of all primary liver tumors and is the most prevalent fatal malignancy in the world, with an annual incidence of approximately one million new cases. In the U.S., there are some 4,000 to 6,000 new cases of HCC diagnosed each year. ZADAXIN’s use also has been investigated with promising early results in malignant melanoma, and non-small cell lung cancer.

International Strategy

While U.S. clinical efforts are at the forefront of our current activities, our commercialization strategy has always been global. Our initial target markets for ZADAXIN have been in emerging growth countries. ZADAXIN is now approved for sale in 27 countries, including China, India and Mexico. ZADAXIN is approved principally for the treatment of hepatitis B and hepatitis C, and also in certain countries as a vaccine adjuvant for patients with weakened immune systems and as an adjuvant to chemotherapy for the treatment of various cancers. Additional marketing approvals are pending in significant hepatitis markets such as Turkey and Hong Kong. Commercial activities in selected countries where ZADAXIN is approved for sale, and most significantly in China, have played an important role in our early development. We believe that the demonstration of continued progress in this international sales program will significantly increase the value of any future development or marketing alliance to our shareholders. Overseas efforts also provide invaluable experience in the successful marketing and sales of ZADAXIN, particularly in economically challenged conditions.

Together with Sigma-Tau, we are engaged in a regulatory development strategy for ZADAXIN targeting a pan-European hepatitis C registration intended to run concurrently with

U.S. registration efforts. Sigma-Tau has exclusive marketing rights for ZADAXIN in most Western European countries. Sigma-Tau is responsible for funding the ZADAXIN European hepatitis C regulatory efforts utilizing the U.S. phase 3 clinical trial data that SciClone will provide to Sigma-Tau. In addition, Sigma-Tau has agreed to fund and conduct phase 2 and 3 oncology clinical trials in Europe. Combination therapy of ZADAXIN with the cytotoxic agent dacarbazine (DTIC) for the treatment of malignant melanoma is the first clinical effort of this collaboration, and the clinical trial is expected to commence in 2002.

In Japan, we are conducting a phase 3 clinical trial in over 300 patients using ZADAXIN as a monotherapy for the treatment of hepatitis B (HBV). In March 2002 we announced positive preliminary data on the first evaluated one-third of these patients indicating that, after 6 months of therapy and 12 months of follow up, 24% demonstrated a successful interruption of viral replication, as measured by sustained seroconversion of hepatitis B e-antigen (loss of HBeAg and the development of antibody to HBeAg). By comparison, published data on lamivudine, the drug most widely used for treatment of hepatitis B worldwide, indicate that lamivudine is capable of inducing sustained HBeAg seroconversion in 16% of Asian patients that took the drug for one year. Over two-thirds of the patients in the trial have already completed the therapy and follow-up evaluation periods. The remaining patients are scheduled to complete the therapy and evaluation periods by the end of 2002. There are approximately 31.5 million carriers of HBV in Japan, of which approximately 10 percent are chronically infected.

We also plan to continue to supply ZADAXIN to qualified investigators outside of the U.S. and Europe for non-company sponsored hepatitis and cancer studies. For example, currently, leading oncology researchers in Australia are studying ZADAXIN in combination with dendritic cell-based vaccination for malignant melanoma, the first pure immunotherapy combination study for ZADAXIN in cancer. Malignant melanoma is one of the most prevalent cancers in Australia. Worldwide, there are at least 50,000 new cases of malignant melanoma diagnosed each year, and there currently is no effective treatment.

Second Generation Immune System Enhancers

In 1999, we acquired exclusive rights to a new class of immunomodulators which in preclinical studies enhanced the immune system in a manner similar to ZADAXIN. At least one of these compounds, SCV-07, has the potential to be orally active (ZADAXIN is administered as a subcutaneous injection). With the $300,000 grant awarded by the U.S. Civilian Research and Development Foundation’s “Next Steps to Market Program”, several preclinical and clinical studies of SCV-07 treatment in tuberculosis, or TB, have been conducted in collaboration with Verta Ltd., a biotechnology company located in St. Petersburg, Russia. These studies have shown potential for efficacy in this difficult to treat and emerging disease. SCV-07 and its related class of compounds are covered by a composition of matter patent in the U.S. as well as for their use as immunomodulators. In 2001 we were granted a U.S. composition of matter patent for various analogs of ZADAXIN that we have determined could have proprietary therapeutic or biologic distinctions from its current “natural synthetic” formulation, such as length of circulation in the blood or alternative delivery techniques.

CPX for Cystic Fibrosis

While ZADAXIN is SciClone’s clear current focus, the Company has also focused on the development of CPX, a novel small molecule protein-repair therapy for cystic fibrosis, or CF, a common fatal genetic disorder among Caucasians. Current treatments for CF address only the symptoms, which ultimately include a build-up of viscous mucus in the lungs that harbor infections and which lead to death in most patients. We licensed CPX from the National Institutes of Health (NIH) after the gene encoding for the Cystic Fibrosis Transmembrane Conductance Regulator (CFTR) protein was identified. In preclinical studies conducted at the NIH utilizing several different approaches to examine the efficacy of CPX, including the use of cells explanted from cystic fibrosis patients, CPX demonstrated the ability to repair the two principal protein defects underlying the cause of CF in most patients at the cellular level: it enables the defective protein to travel through the cell and reach the epithelial cell membrane, a process called “trafficking”, and improves an originally impaired transport of chloride ions across the cell membrane. Because of erratic digestive absorption patterns in CF patients our first U.S. phase 2 trial aimed at demonstrating this protein repair activity in CF patients did not produce the sustained circulatory drug levels required to assess efficacy. We reformulated CPX to prepare for additional toxicology and early human studies and may need to conduct further reformulation before pursuing additional studies. We are exploring further development efforts and opportunities for CPX. We have been granted Orphan Drug Status for CPX in both the U.S. and Europe, protecting market exclusivity. The NIH has granted us an exclusive license for a class of related compounds, one of which, DAX, is another protein-repair candidate. DAX currently is in preclinical development.

Results of Operations

Product Sales

Product sales were $3,948,000 for the three-month period ended March 31, 2002, as compared to $3,113,000 for the corresponding period in 2001. The growth was largely due to increased sales to our importers in China.

For the three-month period ended March 31, 2002, all of our product sales were derived from sales of ZADAXIN, and China accounted for 89% of this revenue. Sales emphasis is concentrated in China because, as one of our more developed markets, marketing expenditures are more likely to benefit sales and profits compared to newer markets, which require investment and development spending.

Cost of product sales was $792,000 or 20% of product sales for the three-month period ended March 31, 2002, as compared to $598,000 or 19% of product sales for the corresponding period in 2001. We expect cost of product sales to vary from quarter to quarter, depending upon the level of ZADAXIN sales, the absorption of fixed product-related costs, and any charges associated with excess or expiring finished product inventory.

Research and Development

Research and development expenses were $2,526,000 for the three-month period ended March 31, 2002, as compared to $1,741,000 for the corresponding period in 2001. The increase

was primarily to support our late-stage clinical programs for ZADAXIN in the U.S. and Japan. The initiation and continuation of ZADAXIN, CPX and other product clinical development programs has had, and will continue to have, the largest and most significant effect on our research and development expenses and is expected to require us to seek additional capital resources. In general, we expect product research and development expenses to increase significantly in absolute dollars over the next several years and to vary quarter to quarter as we pursue our strategy of initiating additional preclinical and clinical trials and testing, acquiring product rights, and expanding regulatory activities.

Sales and Marketing

Sales and marketing expenses were $2,008,000 for the three-month period ended March 31, 2002, as compared to $2,090,000 for the corresponding period in 2001. The decrease was related to slightly lower promotional and advertising expenses. We expect our marketing expenses to vary quarter to quarter and to increase in the next several years as we expand our commercialization and marketing efforts and pursue additional strategic collaborations.

General and Administrative

General and administrative expenses were $992,000 for the three-month period ended March 31, 2002, as compared to $1,017,000 for the corresponding period in 2001. The decrease was related to decreased fees for professional services and expenses related to annual reports. In the near term, we expect general and administrative expenses to vary quarter to quarter as we augment 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

Interest and investment income was $76,000 for the three-month period ended March 31, 2002, as compared to $264,000 for the corresponding period in 2001. The decrease was due to lower average invested cash balances and lower interest rates.

Interest and Investment Expense

Interest and investment expense was $90,000 for the three-month period ended March 31, 2002, as compared to $63,000 for the corresponding period in 2001. The increase was due to the interest accrued on the additional senior unsecured convertible notes that we issued in the first quarter of 2001.

Other Income (Expense), net

Other income/(expense), net was $(19,000) for the three-month period ended March 31, 2002, as compared to $7,000 for the corresponding period in 2001.

Liquidity and Capital Resources

At March 31, 2002 and 2001, we had $16,525,000 and $21,057,000, respectively, in cash, cash equivalents and short-term investments, $633,000 of which was restricted cash at each date. The short-term investments consist primarily of highly liquid marketable securities.

Net cash used by us in operating activities amounted to $414,000 for the three-month period ended March 31, 2002. Net cash used in operating activities in the 2002 period was less than our net loss for that period due to the receipt of a payment from Sigma-Tau of $2,685,000 for a clinical trial collaboration which increased deferred revenue balances by $2,685,000, partially offset by increases in accounts receivable and inventories and decreases in accrued compensation and employee benefits.

Net cash used by us in investing activities amounted to $43,000 for the three-month period ended March 31, 2002 and related primarily to the purchase of $36,000 in property and equipment.

Net cash provided by financing activities amounted to $471,000 for the three-month period ended March 31, 2002. Net cash provided by financing activities consisted of $442,000 related to exercises of outstanding options under our employee stock option plans and $29,000 for the issuance of common stock under our employee stock purchase plan.

Our contractual obligations and other commitments as of March 31, 2002 are as follows:


	Payments Due by Period

Contractual			Less than 1
Obligations	Total		year		1-3 years		4-5 years		After 5 years

Long Term Debt	$	5,600,000		—		—	$	5,600,000		—
Operating Leases	$	5,314,000	$	1,321,000	$	2,714,000	$	1,279,000		—
Total Contractual Cash Obligations	$	10,914,000	$	1,321,000	$	2,714,000	$	6,879,000		—

Amount of Commitment Expiration Per Period

Other Commercial

Total Amounts

Less than 1

Commitments

Committed

year

1-3 years

4-5 years

After 5 years

Letter of Credit

633,000

—

There are no officers or directors that were involved in related party transactions in the three-month period ended March 31, 2002.

Management intends to give priority use of the Company’s financial resources to its clinical programs in the United States. Management believes our existing capital resources and interest on funds available are adequate to maintain our current and planned operations into 2003. We will need to obtain additional capital to support our long-term product development and commercialization programs. The need, timing and amount of additional funding will depend upon numerous factors, including the level of ZADAXIN sales, the timing and amount of manufacturing costs related to ZADAXIN and CPX, the availability of complementary products, technologies and businesses, the initiation and continuation of preclinical and clinical trials and testing, particularly ZADAXIN trials in the U.S. and Japan, the timing of regulatory approvals, developments in relationships with existing or future collaborative parties and the status of competitive products. In the event we need to raise additional financing, the unavailability or the

timing of any financing could prevent or delay our long-term product development and commercialization programs, either of which would severely hurt our business.

Risk Factors

You should carefully consider the risks described below, in addition to the other information in this report on Form 10-Q, 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.

Our phase 3 program in the U.S. for the approval of ZADAXIN in combination with pegylated interferon for the treatment of hepatitis C may fail, which will harm our business.

We conservatively designed a phase 3 study program based on the use of ZADAXIN in combination with pegylated interferon. There can be no assurances that the results from our previous phase 2 and phase 3 hepatitis C studies which enabled us to produce this design will carryover to the trials involving a combination of ZADAXIN and pegylated interferon and any resulting data may be insufficient to demonstrate efficacy under FDA guidelines. We may not be able to enroll patients quickly enough to meet our expectations for completing the trial. The independent use of the pegylated form of interferon may perform better than anticipated. If that results, our efforts to market and sell ZADAXIN in combination with pegylated interferon will be impaired.

We may not be able to successfully develop or commercialize our products.

Many of our products are in the development stage and will require the commitment of substantial resources, devoted to extensive research, development, preclinical testing, clinical trials, manufacturing scale-up and regulatory approval prior to being ready for sale. We cannot assure you that commercially viable products will result from these efforts. 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. We have limited experience in conducting and managing U.S. 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 perform their obligations to us. 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. We have experienced difficulties with the formulation of CPX which has delayed its further development. Our future revenue growth depends on increased market acceptance and commercialization of ZADAXIN in additional countries, particularly in the U.S., Europe and Japan. If we fail to successfully market ZADAXIN, or if we cannot commercialize this drug in the U.S. and other additional markets, our revenue and operating results will suffer. 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

and prospective strategic partners that our products are an attractive alternative to other treatments and therapies, and manufacture products in sufficient quantities with acceptable quality and at an acceptable cost.

If we fail to satisfy and comply with governmental regulations or if government regulations change, our business will suffer.

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 change from time to time and new regulations may be adopted. For example, in prior years, legislation has been introduced in the U.S. Congress that would restrict the duration of the marketing exclusivity of an orphan drug. There can be no assurances that this type of legislation will not be reintroduced and passed into law, or that the benefits of the existing statute will remain in effect. Our failure to satisfy and comply with regulations adopted by the FDA, and comparable agencies in state and local jurisdictions and in foreign countries, may delay or stop approval of our drugs. In particular, such failure can, among other things, result in warning letters, fines, suspensions of regulatory approvals, product recalls or seizures, operating restrictions, injunctions, total or partial suspension of production, civil penalties, and criminal prosecutions. Furthermore, additional government regulation may be established or imposed by legislation or otherwise, which could prevent or delay regulatory approval of ZADAXIN or any of our other future products. 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, or prevent us from receiving market approval in the future. There is no assurance that ZADAXIN, or any of our other products, will demonstrate efficacy sufficient to obtain approval by the FDA or its counterpart regulatory agencies in other countries.

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 to impose costly procedures upon our activities. If regulatory approval of our products is granted, such approval may impose limitations on the indicated uses for which our products may be marketed. The pegylated interferon we will use in our phase 3 program in the U.S. has not yet been approved by the FDA. If this pegylated interferon is not approved by the FDA, we would need to conduct an additional trial with an approved form, resulting in additional delays and expenses.

If we fail to obtain regulatory approvals for our products in countries where we have targeted regulatory approval, we may not be able to sustain or increase our revenues and our stock price may decline.

The research, preclinical and clinical development, manufacturing, marketing and sale of ZADAXIN and our other drug candidates are subject to extensive regulation by governmental authorities. ZADAXIN and any other products we may sell in countries outside the U.S. must be

approved by the foreign counterparts of the FDA before they can be sold in any jurisdiction. Obtaining regulatory approval is time-consuming and expensive. In some countries where we are contemplating marketing and selling ZADAXIN, the regulatory approval process for drugs that have not been previously approved in countries with established clinical trial review procedures is uncertain, and this may delay the grant of regulatory approvals for ZADAXIN. In addition, to secure these regulatory approvals, we will need, among other things, to demonstrate favorable results from additional clinical trials of ZADAXIN and the safety and efficacy of CPX as a treatment for cystic fibrosis in preclinical and clinical trials. There can be no assurance that we will ultimately obtain regulatory approvals in our targeted countries in a timely and cost-effective manner or at all. Our failure to obtain the required regulatory approvals so that we can develop, market and sell our products in countries where we currently do not have such rights may limit our revenues.

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 approvals in these countries. Failure to obtain additional regulatory approvals will harm our operating results. In addition, adverse results that occur in our clinical trials could result in restrictions on the use of ZADAXIN.

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

Our ability to achieve and sustain operating profitability depends in large part on our ability to commence, execute and complete clinical programs for, and obtain additional regulatory approvals for ZADAXIN and other drug candidates, particularly in the U.S., Europe and Japan, increase ZADAXIN sales in existing markets, and launch ZADAXIN in new markets. We cannot assure you that we will ever achieve more significant levels of sales or that we will receive additional ZADAXIN market approvals.

Our current sales levels of ZADAXIN are not expected to generate all the funds we anticipate will be needed to support our current plans for product development including our U.S. phase 3 clinical trials for ZADAXIN. We will need to obtain additional financing to support our product development and commercialization programs. We may seek additional funds through public and private stock offerings, arrangements with corporate partners, borrowings under lease lines of credit or other sources. If we cannot raise the necessary funds, we will have to reduce our capital expenditures, curtail or delay our phase 3 clinical trials, scale back our development of new products, reduce our workforce and out-license to others products or technologies that we otherwise would seek to commercialize ourselves.

The amount of capital we will need will depend on many factors, including: the timing, location, scope and results of ongoing and planned preclinical studies and clinical trials; the cost of manufacturing or obtaining preclinical and clinical materials; the timing and cost involved in applying for and obtaining FDA and international regulatory approvals; whether we elect to establish additional partnering arrangements for development, sales, manufacturing, and marketing of our products; the level of future ZADAXIN sales; expense levels for our international sales and marketing efforts; our ability to establish and maintain strategic

arrangements for development, sales, manufacturing and marketing of our products; competing technological and market developments; the costs involved in filing, prosecuting and enforcing patent claims; and whether any or all of our outstanding common stock warrants are exercised and the timing and amount of these exercises.

Many of the foregoing factors are not within our control. If we need to raise additional funds and such funds are not available on reasonable terms, we may be required to delay or cancel our product development and commercialization programs. Any additional equity financing will be dilutive to shareholders, and any debt financing, if available, may include restrictive covenants.

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 March 31, 2002, we had an accumulated deficit of approximately $125,000,000. 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 U.S., and we may never achieve profitability. Our failure to achieve profitability may cause our stock price to decline.

We are 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 financial condition 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 the People’s Republic of China. Sales of ZADAXIN in China may be limited due to its low average personal income, lack of patient cost reimbursement, poorly developed infrastructure, and existing and potential competition from other products, possibly including generics. 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 place relatively few orders from time to time over any six month period and each order is typically for large quantities. 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. Because we use four importing agents in China, our account receivable from any one importing agent is material and if we were unable to collect receivables from any importer, our business and cash-flow would be adversely affected, at least in the short term.

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 pricing approvals and reimbursement, product health registrations and importation permits; unexpected changes in regulatory requirements; difficulties in staffing and managing

foreign operations; long payment cycles; difficulties in accounts receivable collection; difficulties in enforcing our proprietary rights; currency fluctuations; adverse or deteriorating economic conditions; and potential adverse tax consequences.

We do not have product sales in the U.S. 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.

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 will 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. In addition, 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.

If we are not able to establish and maintain adequate manufacturing and supply 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 regulatory requirements and at an acceptable cost. We may not be able to maintain the long-term manufacturing relationships we currently have with our suppliers and we anticipate changes will be needed if our volume requirements increase. Manufacturing interruptions could significantly delay clinical development of potential products and reduce third-party or clinical researcher interest and support of proposed trials. These interruptions 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.

In some countries, a manufacturing change may require additional regulatory approvals. If we do not obtain the required regulatory approvals for a manufacturing change in a timely fashion, new ZADAXIN marketing approvals may be delayed or sales may be interrupted until the manufacturing change is approved. Either of these results would harm our business.

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.

If we do not obtain rights to additional products from third parties, our prospects for future revenue may decline.

We are only actively pursuing clinical development of ZADAXIN and CPX at this time. If we do not advance SCV-07 and DAX, the other products to which we have in-licensed rights, from preclinical into clinical development, we may lose the rights to these products. We may also have a shortage of drugs to develop and commercialize if we do not license or otherwise acquire rights to additional drugs. Any shortage in the number of drugs that we are able to develop and commercialize may reduce our prospects for future revenue.

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. 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 cause our business to suffer and our stock price to decline. In addition, our relationships with these companies may not be successful. Disputes may arise over ownership rights to intellectual property, know-how or technologies developed with our collaborators, and we may not be able to negotiate similar additional arrangements in the future to develop and commercialize ZADAXIN or other products.

If we fail to protect our products, technologies and trade secrets, we may not be able to successfully use, manufacture or market and 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, to preserve our trade secrets and to avoid infringing on the proprietary rights of third parties. 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, if any, that issued, 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 or market our products or maintain our competitive position with respect to our products. Many of our patents relating to ZADAXIN have expired, and we have rights to other patents and patent applications relating to ZADAXIN under exclusive licenses. If we breach the terms of any of these licenses, we could lose our rights to these patents and patent applications.

Our commercial success also 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 third-party patents that may relate to our products. 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, even if unmeritorious, 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.

Pharmaceuticals are either not patentable or have only recently become patentable in some of the countries in which we have exclusive rights to ZADAXIN. Past enforcement of intellectual property rights in many of these countries has been limited or non-existent. Future enforcement of patents and proprietary rights in many other countries will likely be problematic or unpredictable. Moreover, the issuance of a patent in one country does not assure the issuance of a similar patent in another country. Claim interpretation and infringement laws vary by nation, so the extent of any patent protection is uncertain and may vary in different jurisdictions.

If we make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.

If appropriate opportunities become available, we may attempt to acquire products, product candidates or businesses that we believe fit strategically with our business. We currently have no commitments or agreements with respect to material acquisitions. If we do undertake any transaction of this sort, the process of integrating an acquired product, product candidate or business may result in operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for our ongoing business development plans. Moreover, we may never realize the anticipated benefits of any acquisition. Future acquisitions could result in in-process research and development expenses, potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or impairment of goodwill and amortization or impairment of other intangible assets, which could adversely affect our business, financial condition and results of operations.

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 to increase. Our success depends on our ability to compete. We believe that the principal competitive factors in this industry include the efficacy, safety, price, therapeutic regimen, manufacturing quality assurance, and patents associated with a given drug. Our competitors include biopharmaceutical companies, biotechnology firms, universities and other research institutions, both in the U.S. and abroad, that are actively engaged in research and development

of products in the therapeutic areas we are pursuing, particularly hepatitis C, hepatitis B, cancer, and cystic fibrosis. Competitors are currently marketing drugs for hepatitis C, hepatitis B and cancer, or have products in late-stage clinical trials.

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 preclinical 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. Increased competitive pressure could lead to intensified price-based competition resulting in lower prices and margins, which would hurt our operating results.

We currently rely on sales of ZADAXIN as a treatment for hepatitis C and hepatitis B as our primary source of revenue. However, several large biopharmaceutical companies have substantial commitments to alpha interferon, an approved drug for treating hepatitis B and hepatitis C, and to lamivudine, an approved drug to treat hepatitis B. 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 hepatitis C, hepatitis B, cystic fibrosis, cancer and other diseases that will be superior to ours. However, in the area of immune system enhancer therapy, we anticipate that our competition for ZADAXIN may be reduced by the fact that ZADAXIN, administered in combination with numerous antiviral and anti-cancer agents, is expected to be complementary rather than competitive to these agents in enhancing the immune system. We believe that we can position ZADAXIN as a complementary rather than competitive drug to many therapies, but cannot guarantee that we will be successful in this endeavor. 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 may create new competitors as well as numerous new opportunities for expanded use of ZADAXIN worldwide. We cannot assure you that we will be able to meet these objectives, however.

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

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, and we cannot assure you that third party insurance coverage and reimbursement will be available for therapeutic products we might develop. In most of the emerging markets in which we sell ZADAXIN or intend to sell ZADAXIN, reimbursement for ZADAXIN under government or private health insurance programs is not yet widely available. The failure to obtain third-party reimbursement for our products, particularly in the U.S., Europe and Japan, will harm our business. In the U.S., proposed health care reforms could limit the amount of third-party reimbursement available for our products. We cannot assure you that additional limitations will not be imposed in the future on drug coverage and reimbursement. In many emerging markets where we have marketing rights to ZADAXIN, government resources

and per capita income may be so low that our products will be prohibitively expensive. In these countries, 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 could cause us to reduce the prices at which we market our drugs, which will reduce our gross margins and may harm our business. 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. The announcement of proposals or reforms 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 the current economic slowdown in the U.S. causes the economies of other countries, particularly those in Asia, Latin America and the Middle East to experience a slowdown or recession, our business will suffer.

The U.S. is the world’s largest consumer and as such, the current economic slowdown in the U.S. may adversely affect the economies of other countries, including the developing countries in Asia, Latin America and the Middle East from which we derive all of our revenues. If the economic conditions in the U.S. continue or worsen, these developing countries may also experience an economic slowdown or recession, which would likely result in a decrease of sales of ZADAXIN. Any decrease in sales of ZADAXIN would harm our operating results, delay our efforts to achieve profitability, and likely cause our stock price to decline.

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 international 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, numerous key responsibilities at SciClone are assigned to a small number of individuals. If we are 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 adversely be 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 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.

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

We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials and waste products. We currently maintain a supply of hazardous materials at our facilities. In the event of an accident, we could be liable for any damages that result, and the liability could exceed our resources. 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.

The price of our common stock has experienced substantial volatility and may fluctuate due to factors beyond our control.

As a result of the September 11, 2001 events in Pennsylvania, New York City and Washington, D.C., U.S. and global economies have weakened, which may result in a decrease in our revenues and cause our stock price to decline. Further, high profile corporate governance and accounting problems and resulting corporate failures have eroded investor confidence. In the wake of these events, U.S. and global capital markets have experienced a period of extreme volatility, and this may continue for some time.

In addition, there has been significant volatility in the market prices for publicly traded shares of pharmaceutical and biotechnology companies, including ours. The following factors may have an adverse impact on the market price of our common stock: significant negative changes in the major equity market indices; announcements of technical or product developments by us or our competitors; governmental regulation; health care legislation; public announcements regarding advances in the treatment of the disease states that we are targeting; public announcements from government officials relating to the biotechnology or pharmaceutical industries; patent or proprietary rights developments; changes in third-party reimbursement policies for our products; and fluctuations in our operating results. In addition, the price of our common stock may not remain at or exceed current levels.

If the current war on terrorism causes economic slowdowns in the economies of certain countries our business will suffer.

The United States and its allied nations are aggressively attacking terrorism with military and economic actions. If these actions lead to economic slowdowns in the economies of developing countries in Asia, Latin America and the Middle East from which we currently derive all of our product revenue, then our sales could decrease. Any decrease in sales would harm our operating results, delay our efforts to achieve profitability, and likely cause our stock price to decline.

Our indebtedness may result in future liquidity problems.

As of March 31, 2002, we had $5.6 million in convertible notes payable, of which $4.0 million were issued in the quarter ended December 31, 2000 and $1.6 million were issued in the quarter ended March 31, 2001. This indebtedness, or additional debt we may incur to fund our

operations, may make it more difficult for us to obtain additional financing. The notes are payable five years after issuance unless converted into common stock at the sole discretion of the holder. If we are unable to satisfy our debt service requirements, substantial liquidity problems could result which would negatively impact our future prospects. As of March 31, 2002 we had cash, cash equivalents and short-term investments of $16.5 million.

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

As of March 31, 2002, stock options for 4,515,614 shares of common stock were outstanding, of which options for 3,352,993 shares were exercisable. Also outstanding as of the same date were warrants exercisable for 1,970,500 shares of common stock and two issues of notes convertible into a total of 684,140 shares of common stock. In addition, the note holder has the right to purchase senior unsecured convertible notes due December 2005 and March 2006. If issued, the additional notes will bear no interest (zero coupon) and 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 shareholders will be reduced and the price of our common stock may fall.

Issuing preferred stock with rights senior to those of our common stock could adversely affect holders of common stock.

Our charter documents give our board of directors the authority to issue additional series of preferred stock without a vote or action by our shareholders. The board also has the authority to determine the terms of preferred stock, including price, preferences and voting rights. The rights of holders of our common stock may be adversely affected by the rights granted to holders of preferred stock. For example, a series of preferred stock may be granted the right to receive a liquidation preference — a pre-set distribution in the event of a liquidation — that would reduce the amount available for distribution to holders of common stock. In addition, the issuance of preferred stock could make it more difficult for a third party to acquire a majority of our outstanding voting stock. As a result, common shareholders could be prevented from participating in transactions that would offer an optimal price for their shares.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in highly liquid and high quality debt securities. Our investments in debt securities are subject to interest rate risk. To minimize the exposure due to an adverse shift in interest rates, we invest in short term securities and maintain an average maturity of less than one year. A hypothetical 60 basis point increase in interest rates would result in an approximate $85,472 decrease (0.6%) in fair value of our available-for-sale securities.

The potential change noted above is based on sensitivity analyses performed on our financial positions at March 31, 2002. Actual results may differ materially.

PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a)		Exhibits

		None.

(b)		Reports on Form 8-K

		None.

SIGNATURES

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


		SCICLONE PHARMACEUTICALS, INC. (Registrant)

Date: May 10, 2002		/s/ Richard A. Waldron

		Richard A. Waldron Chief Financial Officer (Principal Financial & Accounting Officer)

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Sciclone Pharmaceuticals (SCLN) Inactive 10-Q2002 Q1 Quarterly report

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