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 consolidated 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.

Our current primary business objective is to obtain regulatory approval for and commercialize ZADAXIN as part of combination therapy for the treatment of HCV in the United States and in Europe. 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 2004 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 alpha. We intend to complete these trials by the end of 2005 and, if the results are successful, file a NDA by the end of 2006.

We estimate the worldwide market for HBV therapeutics was approximately $480 million in 2004 and it 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 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, 2004, we have an accumulated deficit of approximately $152,000,000. At least over the next few 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 major pharmaceutical markets of 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, our ability to compete in pharmaceutical markets, 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 quarterly net sales for 2005 to be slightly higher to those reported in 2004. Expected research and development expenses for 2005 are higher than research and development expenses for 2004 due to increased expenses for the phase 3 hepatitis C clinical trial in Europe as well as for the development of SCV-07. Expected net loss and net loss per share for 2005 are higher than net loss and net loss per share for 2004 based on higher research and development expenses and general and administrative expenses. Cash, cash equivalents and short-term investments at December 31, 2005 are expected to be lower than at December 31, 2004 primarily due to the expected net loss from operations and the assumption that the $4 million convertible note due in December 2005 will be repaid rather than converted.

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.

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 our Consolidated Financial Statements" in Part II, 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.

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. We exercise judgment in estimating return reserves. 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.

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 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.

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. 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. Our inventory levels decreased during the second half of 2004. We expect to begin to build inventory levels in the second quarter of 2005 to ensure an uninterrupted supply of product for our customers in China. If we are unable to qualify in a timely fashion the product produced by the new contract manufacturer, we may determine that some of this inventory may not be saleable and could result in writedowns of inventory and in a net loss.

At December 31, 2004, we had net intangible assets of $542,000 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.

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 vary 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 organizations or other entities managing the trials and laboratory and other direct expenses are recognized in the period they are estimated to be incurred and the services performed. We monitor active 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.

The preparation of the financial statement footnotes requires us to estimate the fair value of stock options granted to employees and directors. While fair value may be readily determinable for awards of stock, market quotes are not available for long-term, nontransferable stock options because these instruments are not traded. We currently use the Black-Scholes option pricing model to estimate the fair value of employee stock options. Option valuation models require the input of highly subjective assumptions, including stock price volatility. Changes to the subjective input assumptions could materially affect the estimated fair value of our stock options. We are currently evaluating our option valuation methodologies and assumptions in light of a new accounting standard related to employee stock options.

Product sales were $22,765,000, $31,732,000, and $17,101,000 for the years ended December 31, 2004, 2003 and 2002, respectively, and all were derived from sales of ZADAXIN. Sales to customers in China accounted for approximately 91%, 88% and 88% of this revenue for the years ended December 31, 2004, 2003 and 2002, respectively. Product prices have remained stable throughout the 2002, 2003 and 2004 periods. 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 the years ended December 31, 2004, 2003 and 2002, sales to between four and six importing agents in China accounted for approximately 91%, 88% and 88%, respectively of our product sales. The single largest customer accounting for 32%, 52% and 41% of sales for the years ended December 31, 2004, 2003 and 2002, respectively was the same importing agent. As of December 31, 2004, approximately $9,609,000 or, 90% of our accounts receivable were attributable to four customers in China. We perform on-going credit evaluations of our customers' financial condition, and generally do not require collateral from our customers.

Contract revenue was $1,631,000, $806,000, and $671,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The contract revenue includes a $1,000,000 payment we received from Sigma-Tau in June 2004 relating to the completion of enrollment of our U.S. phase 3 HCV clinical trials. The remaining contract revenue recognized in 2002, 2003 and 2004 is 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 U.S. phase 3 HCV clinical trials and the period of sharing the clinical data from with Sigma-Tau in accordance with the requirements under our contract.

Research and development (R&D) expenses were $17,994,000, $18,949,000 and $11,647,000 for the years ended December 31, 2004, 2003, and 2002, respectively. The decrease in 2004 was primarily related to the U.S. phase 3 hepatitis C clinical trials nearing completion by the end of 2005. The increase in 2003 was primarily to support our ZADAXIN phase 3 HCV clinical trials, in the United States. In 2004, 2003 and 2002, R&D expenses represented approximately 53%, 59% and 48%, 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 essentially include clinical trials. Pharmaceutical development costs consist of product formulation and chemical analysis. During 2004, we recorded approximately $4,100,000 on research, $11,800,000 on clinical development, and $2,100,000 on pharmaceutical development activities. This compares to expenses in 2003 of approximately $2,100,000 on research, $14,500,000 on clinical development, and $2,300,000 on pharmaceutical development activities and expenses in 2002 of approximately $2,300,000 on research, $8,300,000 on clinical development, and $1,100,000 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. In general, we expect research and development expenses to increase at least over the next few 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. An expansion or significant extension of our clinical development programs may require us to seek additional capital resources.

Sales and marketing expenses were $9,665,000, $9,018,000 and $8,724,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The year-to-year increases from 2002 to 2004 were related to increased payroll expenses and expenses for advertising and conferences associated with the expansion of our marketing efforts for ZADAXIN. We expect sales and marketing expenses for 2005 to be similar to those incurred in 2004.

General and administrative expenses were $6,311,000, $4,134,000 and $3,902,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The year-to-year increases from 2002 to 2004 were attributable to greater general and administrative activities to support an increased level of research and development on our late-stage clinical programs. In addition, the increase in the 2004 period was attributable to a non-recurring expense incurred in connection with the separation of our former Chief Executive Officer from the Company in July 2004 and to greater general and administrative activities associated with increased securities regulation requirements. In the near term, we expect increased general and administrative expenses as we increase our general and administrative activities to support increased expenditures on business development, legal and regulatory activities.

Interest and investment income was approximately $1,285,000, $266,000 and $323,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The increase from 2003 to 2004 was primarily related to a gain from the sale of equity securities in the amount of approximately $697,000 and the remaining increase was due to higher cash balances earning interest in the 2004 period. Interest expense relating to $5,600,000 of convertible notes payable was $361,000 for each of the years ended December 31, 2004, 2003 and 2002.

Net loss for the years ended December 31, 2004, 2003 and 2002 was $13,278,000, $5,275,000 and $10,037,000, respectively. Net loss was higher in 2004 than in 2003 principally due to higher net sales and gross margin related to the SARS epidemic in China in 2003. Net loss per share for the years ended December 31, 2004, 2003 and 2002 was $0.30, $0.13 and $0.29, respectively. Weighted average shares outstanding for the year ending December 31, 2004, 2003 and 2002 were 44,626,337, 39,568,199 and 35,002,003, respectively. The increases in the shares outstanding are primarily due to financing activities in 2003 and 2002.

At December 31, 2004, we had net operating loss carryforwards for federal income tax purposes of approximately $104,000,000 which expire in the years 2006 through 2024. 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, 2004, we had federal tax credit carryforwards of approximately $5,000,000 which expire in the years 2009 through 2024.

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.

At December 31, 2004, 2003 and 2002, we had $51,299,000, $62,975,000 and $21,150,000, 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, 2005 will be lower than the balance at December 31, 2004. The expected decrease in this balance is attributable to an expected net loss and the assumption that the $4 million convertible note due December 2005 will be repaid rather than converted. 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, 2004, the letters of credit totaled $700,000, one for $633,000 under our lease agreement, the other for $67,000 to facilitate our value added tax filings in Europe.

Net cash used in operating activities totaled $12,335,000, $8,055,000 and $5,890,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Net cash used in operating activities for the year ended December 31, 2004 was less than the net loss primarily due to a $1,599,000 decrease in inventory levels. 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 to provide an uninterrupted supply of ZADAXIN as we transferred production to 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 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 $196,000 of property and equipment during the year ended December 31, 2004.

Net cash provided by financing activities totaled $289,000, $50,074,000 and $10,577,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Net cash provided by financing activities for the year ended December 31, 2004 consisted of approximately $12,000 related to exercises of outstanding options under our employee stock option plans and $277,000 from the issuance of common stock under our employee stock purchase plan. Net cash provided by financing activities for the year ended December 31, 2003 consisted of approximately $44,426,000 from a 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.

The following table summarizes our contractual obligations and other commitments as of December 31, 2004.

                                                               Payments Due by Period
                                     --------------------------------------------------------------------
                                                    Less than                                 More than
Contractual Obligations                 Total         1 year      1-3 years     3-5 years      5 years
- -----------------------------------  ------------  ------------  ------------  ------------  ------------
Convertible notes payable (1)...... $  5,960,000  $  4,336,000  $  1,624,000  $         --  $         --
Operating leases (2)...............    3,623,000     1,396,000     2,198,000        29,000            --
Purchase obligations (3)...........    6,456,000     3,542,000     2,914,000            --            --
Royalty obligations (4)............    1,020,000       420,000       540,000        40,000        20,000
                                     ------------  ------------  ------------  ------------  ------------
Total.............................. $ 17,059,000  $  9,694,000  $  7,276,000  $     69,000  $     20,000
                                     ============  ============  ============  ============  ============

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. If 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 2004.

There are no off-balance sheet arrangements in 2004, 2003 or 2002.

In December 2004, the Financial Accounting Standards Board ("FASB") issued FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R") which revises SFAS 123, and supersedes APB 25, and its related implementation guidance.  Generally the approach in SFAS 123R is similar to the approach described in SFAS 123. However, SFAS 123R requires share-based payments to employees and directors, including grants of stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure is no longer an alternative.  The amount of compensation cost will be measured based on the grant-date fair value of the instruments issued.  Compensation cost will be recognized over the period that an employee or director provides service in exchange for the award.  We expect to adopt SFAS 123R on July 1, 2005.

As permitted by SFAS 123, the Company currently accounts for share-based payments to employees and directors using APB 25's intrinsic value method and, as such, generally recognizes no compensation cost for employee and director stock options. Accordingly, the adoption of SFAS 123R's fair value method will have a significant impact on our result of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss and net loss per share in the Accounting for Stock-Based Compensation section of Note 1 to our consolidated financial statements.

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.

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 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. The regulatory approval processes in the United States and Europe are demanding and typically require 12 months or more in the United States and 18 months or more in Europe from the date of submission of an NDA. 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 from ZADAXIN and our ZADAXIN sales in other jurisdictions could decline.

All new drugs, including our products, which have been developed or are under development, are subject to extensive and rigorous regulation by the FDA and comparable agencies in state and local jurisdictions and in foreign countries. These regulations govern, among other things, the development, testing, manufacturing, labeling, storage, pre-market approval, importation, advertising, promotion, sale and distribution of our products. These regulations may change from time to time and new regulations may be adopted.

Obtaining regulatory approval in developing countries also is time-consuming and expensive. In some countries where we are contemplating marketing and selling ZADAXIN, the regulatory approval process often relies on prior approvals obtained in the United States or in Europe. Without such prior approvals, our ability to obtain regulatory approvals for ZADAXIN in these countries may be delayed or prevented. In addition, to secure these regulatory approvals, we will need, among other things, to demonstrate favorable results from additional clinical trials of ZADAXIN. Even if we are able to complete the clinical trials we have sponsored or are planning in a timely or cost-effective manner, these trials may not fulfill the applicable regulatory approval criteria, in which case we will not be able to obtain regulatory approval in these countries, and we have experienced difficulties in preparing for regulatory approval in Japan. 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.

To obtain regulatory approvals, we must, among other requirements, complete carefully controlled and well-designed clinical trials demonstrating that a particular drug is safe and effective for the applicable disease. We cannot depend on data from prior trial results to predict or demonstrate that our potential drug products are safe and efficacious under regulatory guidelines to qualify for commercial sale. 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 (thymosin alpha 1) 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 an NDA 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-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 an NDA will be approved or that we will submit an NDA based on such results. 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, 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.

Despite the favorable data from our phase 3 hepatitis B clinical trial in Japan, we have identified problems in meeting the requirements for filing a Japanese New Drug Application (JNDA) for ZADAXIN. A JNDA filing requires complete documentation from all phases of the clinical trials. The phase 1 and phase 2 clinical trials, and part of the phase 3 clinical trials, were conducted and sponsored by Schering Plough KK (SPKK), a pharmaceutical company in Japan, under a development agreement with SciClone. After several months of soliciting from SPKK the data and documentation necessary to proceed with the filing in Japan, and after receiving some additional documentation, we have determined that certain information and documentation from earlier stages of the development process has still not been delivered. Furthermore, we are concerned that some of the necessary documentation may not be available at all, and that certain administrative formalities may not have been observed in the drug development process. If the necessary documentation can be obtained or reproduced in the near future, we intend to proceed with the JNDA. We are reviewing our legal rights and remedies with respect to third parties. We continue to seek a resolution of this matter with SPKK.

Each of our two current phase 3 HCV clinical trials in the United States enrolled more than the planned number of 500 patients, one trial treating patients with no liver damage and the other trial treating patients with mild cirrhosis of the liver. The trials require patient treatment for 48 weeks and a follow-up observation period for an additional 24 weeks. Patient dropouts were expected, but have been higher than anticipated. A patient who drops out at any point in the 72 weeks of the trial is considered a "failure to respond" in results of the clinical trial. Dropouts will not prevent us from completing our trials, however, the fewer patients who complete the trial, in general, the higher the positive response rate for the group of remaining ZADAXIN treated patients needs to be to demonstrate statistical significance. Therefore, a higher than anticipated dropout rate lowers our chances of proving statistical significance which could adversely effect our preparation of an NDA.

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.

We are highly dependent upon our ability to attract and retain qualified personnel because of the specialized, scientific and worldwide nature of our business. Following the departure of our Chief Executive Officer on July 14, 2004, we established an Office of the President, and believe that the Company will function effectively while we work to identify a new Chief Executive Officer. However, we may still be affected adversely, particularly if we cannot retain a new Chief Executive Officer in a reasonable time frame. 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.

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. In China, ZADAXIN is approved only for the treatment of HBV. We face competition from certain large, global pharmaceutical companies who are aggressively marketing competing products for the treatment of HBV and other indications where ZADAXIN is used on an off-label basis. In addition, several local companies have introduced lower priced locally manufactured generic thymosin. We expect such competition to continue and there could be a negative impact on the price and the volume of ZADAXIN sold in China, which would harm our business.

Our 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. 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, Europe or Japan 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.

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

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

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

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

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

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

We rely on third parties, who are subject to regulatory oversight, to supply our clinical and commercial products. 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. Roche is our exclusive supplier of pegylated interferon alpha for our current U.S. phase 3 HCV clinical trials and we have received all the pegylated interferon to be used in these clinical trials. Any recall of pegylated interferon alpha could delay the clinical trials or detract from the integrity of the trial data, in which case, Roche's 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.

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 qualifying a new supplier for ZADAXIN with regulatory agencies. This process, quality assurance and other steps 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.

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. We may consider and undertake various strategies to expand our portfolio of potential products, including acquiring product candidate rights through licenses or other relationships, or through other strategic relationships including acquisitions of other companies that may have proprietary rights to other development candidates or the capability to discover new drug candidates. Such transactions could require a substantial amount of our financial resources, or, if equity is involved, may result in substantial dilution to current stockholders. Strategic transactions also require substantial management time and effort and are subject to various risks that could adversely affect us or our financial results.

To fully develop our products, we will need to commit substantial resources to extensive research, development, pre-clinical testing, clinical trials, manufacturing scale-up and regulatory approval prior to 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 lead to an unfavorable outcome on the results of our operations.

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

We 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 experienced significant operating losses since our inception, and as of December 31, 2004, we had an accumulated deficit of approximately $152 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 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.

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.

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.

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

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.

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

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

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

• progress and results of clinical trials involving ZADAXIN;

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

• 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.

As of December 31, 2004, stock options to purchase 6,706,613 shares of common stock were outstanding, of which options to purchase 4,971,804 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, however, the exercise term of all of these warrants expired in January 2005. As of December 31, 2004 two notes convertible into a total of 684,140 shares of common stock were outstanding. 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 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.

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 9, 2005, only one director has adopted such a plan, and other directors or officers may do so in the future. In general our officers and directors have rarely sold stock in the Company, though they have held options or stock for many years. However, the separation of our former Chief Executive Officer from the Company in July 2004 may affect his personal financial plans and result in both his exercising of stock options and selling of stock which may have affected or may in the future affect the trading price of our stock. As of March 9, 2005, the former CEO has 1,610,454 shares of stock options outstanding and exercisable that will expire between April 2005 and July 2006. We expect future sales by officers and directors either under 10b5-1 plans or otherwise as a result of their personal financial planning. We do not believe the volume of such sales would affect our trading price; however, the market could react negatively to sales by our officers and directors, which could affect the trading price of our stock.

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 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.

Future changes in financial accounting standards, including proposed changes in accounting for stock options, may cause adverse, unexpected fluctuations in the timing of the recognition of revenues or expenses and may affect our financial position or results of operations. New pronouncements and varying interpretations of pronouncements have occurred with frequency and may occur in the future and we may make changes in our accounting policies in the future. Compliance with changing regulations concerning corporate governance and public disclosure has resulted in and may continue to result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, are creating uncertainty for companies such as ours and costs are increasing as a result of this uncertainty and other factors. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment has and may continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating product development activities to compliance activities.

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

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.

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 and highly rated, highly liquid short-term municipal securities. 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 $233,246 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, 2004. Actual results may differ materially.

Our purchases from one of our contract manufacturers are denominated in euros and this exposes us to foreign currency rate fluctuations. However, substantially all our sales and most of our manufacturing costs to date have been in U.S. dollars.

                                                                                           December 31,
                                                                                    ----------------------------
                                                                                        2004           2003
                                                                                    -------------  -------------
                                      ASSETS                                                                    
Current assets:
  Cash and cash equivalents....................................................... $  41,204,000  $  52,899,000
  Restricted short-term investments...............................................       700,000        695,000
  Other short-term investments....................................................     9,395,000      9,381,000
  Accounts receivable, net of allowance of $452,000 in 2004 and $638,000 in 2003..    10,279,000     10,142,000
  Inventories.....................................................................     4,179,000      5,778,000
  Prepaid expenses and other current assets.......................................     1,478,000      2,456,000
                                                                                    -------------  -------------
     Total current assets.........................................................    67,235,000     81,351,000
Property and equipment, net.......................................................       398,000        325,000
Intangible assets, net............................................................       542,000        612,000
Other assets......................................................................     1,534,000      1,534,000
                                                                                    -------------  -------------
     Total assets................................................................. $  69,709,000  $  83,822,000
                                                                                    =============  =============
                                                                                                                
                       LIABILITIES AND STOCKHOLDERS' EQUITY                                                     
Current liabilities:
  Accounts payable................................................................ $   2,225,000  $   3,423,000
  Accrued compensation and employee benefits......................................     2,177,000      1,440,000
  Accrued professional fees.......................................................       452,000        481,000
  Other accrued expenses..........................................................       917,000        631,000
  Accrued clinical trials expense.................................................     1,500,000      1,889,000
  Deferred revenue................................................................       537,000        537,000
  Convertible note payable .......................................................     4,000,000             --
                                                                                    -------------  -------------
     Total current liabilities....................................................    11,808,000      8,401,000
Deferred revenue..................................................................       134,000        671,000
Other long-term liabilities.......................................................     1,044,000        900,000
Convertible note payable..........................................................     1,600,000      5,600,000
Commitments and contingencies
Stockholders' equity:
   Preferred stock; $0.001 par value; 10,000,000 shares authorized; no
      shares outstanding..........................................................
  Common stock; $0.001 par value; 75,000,000 shares authorized; 44,677,845
      and 44,484,144 shares issued and outstanding in 2004 and 2003, respectively.        45,000         44,000
  Additional paid-in capital......................................................   206,608,000    206,320,000
  Accumulated other comprehensive income..........................................        38,000        176,000
  Accumulated deficit.............................................................  (151,568,000)  (138,290,000)
                                                                                    -------------  -------------
     Total stockholders' equity...................................................    55,123,000     68,250,000
                                                                                    -------------  -------------
     Total liabilities and stockholders' equity................................... $  69,709,000  $  83,822,000
                                                                                    =============  =============

                                                     Years Ended December 31,
                                             ----------------------------------------
                                                 2004          2003          2002
                                             ------------  ------------  ------------
Revenues:
  Product sales............................ $ 22,765,000  $ 31,732,000  $ 17,101,000
  Contract revenues........................    1,631,000       806,000       671,000
                                             ------------  ------------  ------------
    Total revenues.........................   24,396,000    32,538,000    17,772,000
Cost of product sales......................    4,577,000     5,636,000     3,487,000
                                             ------------  ------------  ------------
Gross margin...............................   19,819,000    26,902,000    14,285,000
                                             ------------  ------------  ------------
Operating expenses:
  Research and development.................   17,994,000    18,949,000    11,647,000
  Sales and marketing......................    9,665,000     9,018,000     8,724,000
  General and administrative...............    6,311,000     4,134,000     3,902,000
                                             ------------  ------------  ------------
    Total operating expenses...............   33,970,000    32,101,000    24,273,000
                                             ------------  ------------  ------------
Loss from operations.......................  (14,151,000)   (5,199,000)   (9,988,000)
Interest and investment income(1)..........    1,285,000       266,000       323,000
Interest expense...........................     (361,000)     (361,000)     (361,000)
Other income (expense), net................      (51,000)       19,000       (11,000)
                                             ------------  ------------  ------------
Net loss................................... $(13,278,000) $ (5,275,000) $(10,037,000)
                                             ============  ============  ============

Basic and diluted net loss per share....... $      (0.30) $      (0.13) $      (0.29)
                                             ============  ============  ============

Weighted average shares used in computing
  basic and diluted net loss per share.....   44,626,337    39,568,199    35,002,003
                                             ============  ============  ============

                                                                                     Accumulated
                                                                                        Other
                                                 Common Stock           Additional   Comprehensive                   Total
                                          ---------------------------    Paid-in        Income      Accumulated   Stockholders'
                                             Shares        Amount        Capital        (Loss)        Deficit        Equity
                                          ------------  -------------  ------------  ------------  -------------  ------------
Balance at December 31, 2001.............  32,474,150  $ 145,713,000  $         --  $     39,000  $(122,978,000) $ 22,774,000
Issuance of common stock from exercise
  of stock options, warrants and
  employee stock purchase plan...........     342,306        663,000            --            --             --       663,000
Issuance of common stock from private
  placements.............................   4,088,460      9,914,000            --            --             --     9,914,000
Net loss.................................          --             --            --            --    (10,037,000)  (10,037,000)
Net unrealized gain on
  available-for-sale securities..........          --             --            --        40,000             --        40,000
                                                                                                                  ------------
Total comprehensive loss.................                                                                          (9,997,000)
                                          ------------  -------------  ------------  ------------  -------------  ------------
Balance at December 31, 2002.............  36,904,916    156,290,000            --        79,000   (133,015,000)   23,354,000
Issuance of common stock from exercise
  of stock options, warrants and
  employee stock purchase plan...........     847,171      3,256,000            --            --             --     3,256,000
Issuance of common stock to Sigma-Tau....     504,938      1,800,000            --            --             --     1,800,000
Reincorporation 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            --             --       592,000
Issuance of common stock in secondary
  offering, net of financing costs.......   6,000,000          6,000    44,420,000            --             --    44,426,000
Net loss.................................          --             --            --            --     (5,275,000)   (5,275,000)
Net unrealized gain on
  available-for-sale securities..........          --             --            --        97,000             --        97,000
                                                                                                                  ------------
Total 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
Issuance of common stock from exercise
  of stock options, warrants and
  employee stock purchase plan...........     193,701          1,000       288,000            --             --       289,000
Net loss.................................          --             --            --            --    (13,278,000)  (13,278,000)
Net unrealized loss on
  available-for-sale securities..........          --             --            --      (138,000)            --      (138,000)
                                                                                                                  ------------
Total comprehensive loss.................                                                                         (13,416,000)
                                          ------------  -------------  ------------  ------------  -------------  ------------
Balance at December 31, 2004.............  44,677,845  $      45,000  $206,608,000  $     38,000  $(151,568,000) $ 55,123,000
                                          ============  =============  ============  ============  =============  ============

                                                                                     Years Ended December 31,
                                                                             ----------------------------------------
                                                                                 2004          2003          2002
                                                                             ------------  ------------  ------------
Operating activities:
Net loss................................................................... $(13,278,000) $ (5,275,000) $(10,037,000)
Adjustments to reconcile net loss to net cash used in operating activities:
  Depreciation and amortization............................................      190,000       160,000       531,000
  Amortization of deferred financing costs.................................       25,000        25,000        25,000
  Other non-cash (income) expense, net.....................................       (3,000)      (13,000)      (21,000)
  Gain on sale of equity investment........................................     (697,000)           --            --
  Changes in operating assets and liabilities:
     Accounts receivable...................................................     (137,000)     (866,000)     (484,000)
     Inventories...........................................................    1,599,000    (2,347,000)      628,000
     Prepaid expenses and other assets.....................................      952,000      (355,000)     (967,000)
     Accounts payable and other accrued expenses...........................     (912,000)      345,000     1,576,000
     Accrued clinical trials expense.......................................     (389,000)      923,000       670,000
     Accrued professional fees.............................................      (29,000)     (198,000)       46,000
     Accrued compensation and employee benefits............................      737,000       352,000       129,000
     Long-term liabilities.................................................      144,000            --            --
     Deferred revenue......................................................     (537,000)     (806,000)    2,014,000
                                                                             ------------  ------------  ------------
       Net cash used in operating activities...............................  (12,335,000)   (8,055,000)   (5,890,000)
                                                                             ------------  ------------  ------------
Investing activities:
  Purchases of property and equipment......................................     (196,000)     (303,000)      (66,000)
  Proceeds from sales of short-term and equity investments.................      697,000     1,000,000        94,000
  Proceeds from maturities of short-term investments.......................    6,000,000       500,000     2,600,000
  Payments on purchases of short-term investments..........................   (6,150,000)     (550,000)   (6,600,000)
                                                                             ------------  ------------  ------------
       Net cash provided by (used in) investing activities.................      351,000       647,000    (3,972,000)
                                                                             ------------  ------------  ------------
Financing activities:
  Proceeds from issuances of common stock, net.............................      289,000    50,074,000    10,577,000
                                                                             ------------  ------------  ------------
       Net cash provided by financing activities...........................      289,000    50,074,000    10,577,000
                                                                             ------------  ------------  ------------
Net increase (decrease) in cash and cash equivalents.......................  (11,695,000)   42,666,000       715,000
Cash and cash equivalents, beginning of year                                  52,899,000    10,233,000     9,518,000
                                                                             ------------  ------------  ------------
Cash and cash equivalents, end of year..................................... $ 41,204,000  $ 52,899,000  $ 10,233,000
                                                                             ============  ============  ============
Supplemental disclosures of cash flow information:
  Cash paid for interest................................................... $    336,000  $    336,000  $    336,000
Non-cash investing activities:
  Obligations incurred related to prepaid royalties........................ $         --  $  1,200,000  $         --

                                                                             2004          2003          2002
                                                                         ------------  ------------  ------------
Weighted-average fair value of stock options granted................... $       3.22  $       4.10  $       2.75
Risk-free interest rate................................................         2.59 %        2.00 %        2.00 %
Dividend yield.........................................................         0.00 %        0.00 %        0.00 %
Volatility factor of the expected market price of our common stock.....        87.36 %       93.29 %       95.62 %
Weighted-average expected life of option (years).......................         4.00          4.03          3.88

Weighted-average fair value of employee stock purchase plan purchases.. $       1.83  $       1.74  $       0.99
Risk-free interest rate................................................         3.32 %        2.00 %        2.00 %
Dividend yield.........................................................         0.00 %        0.00 %        0.00 %
Volatility factor of the expected market price of our common stock.....        85.34 %       94.31 %       95.62 %
Weighted-average expected life of option (years).......................         0.24          0.25          0.25

                                                                             2004          2003          2002
                                                                         ------------  ------------  ------------
Net loss as reported................................................... $(13,278,000) $ (5,275,000) $(10,037,000)
Total stock-based employee compensation expense determined ............
  under the fair value based method for all awards.....................   (4,257,000)   (3,010,000)   (2,283,000)
                                                                         ------------  ------------  ------------
Net loss  -- pro forma................................................. $(17,535,000) $ (8,285,000) $(12,320,000)
                                                                         ============  ============  ============

Basic and diluted net loss per share -- as reported.................... $      (0.30) $      (0.13) $      (0.29)
                                                                         ============  ============  ============

Basic and diluted net loss per share -- pro forma...................... $      (0.39) $      (0.21) $      (0.35)
                                                                         ============  ============  ============

                                                                             Available-For Sale Securities
                                                                         ----------------------------------------
                                                                                          Gross       Estimated
                                                                          Amortized     Unrealized       Fair
                                                                             Cost         Gains         Value
                                                                         ------------  ------------  ------------
December 31, 2004:                                                                                               
  Certificates of deposit.............................................. $    805,000  $         --  $    805,000
  U.S. government obligations..........................................   22,843,000            --    22,843,000
  Short-term municipal securities......................................    9,200,000            --     9,200,000
  Corporate equity securities .........................................       51,000        38,000        89,000
                                                                         ------------  ------------  ------------
                                                                        $ 32,899,000  $     38,000  $ 32,937,000
                                                                         ============  ============  ============
                                                                                                                 
December 31, 2003:                                                                                               
  Certificates of deposit.............................................. $    798,000  $         --  $    798,000
  U.S. government obligations..........................................   38,259,000            --    38,259,000
  Short-term municipal securities......................................    9,050,000            --     9,050,000
  Corporate equity securities .........................................       51,000       176,000       227,000
                                                                         ------------  ------------  ------------
                                                                        $ 48,158,000  $    176,000  $ 48,334,000
                                                                         ============  ============  ============

                                                                                December 31,
                                                                         --------------------------
                                                                             2004          2003
                                                                         ------------  ------------              
Prepaid insurance...................................................... $    694,000  $    717,000
Prepaid rent...........................................................      102,000       100,000
Prepaid clinical trial expense.........................................      247,000     1,085,000
VAT receivable.........................................................      142,000       208,000
Other prepaid expenses.................................................      293,000       346,000
                                                                         ------------  ------------
                                                                        $  1,478,000  $  2,456,000
                                                                         ============  ============

                                                                                December 31,
                                                                         --------------------------
                                                                             2004          2003
                                                                         ------------  ------------              
Raw materials.......................................................... $  1,517,000  $  1,577,000
Work in process........................................................      276,000     1,955,000
Finished goods.........................................................    2,386,000     2,246,000
                                                                         ------------  ------------
                                                                        $  4,179,000  $  5,778,000
                                                                         ============  ============

                                                                                December 31,
                                                                         --------------------------
                                                                             2004          2003
                                                                         ------------  ------------              
Office furniture and fixtures                                           $    290,000  $    243,000
Office equipment                                                             788,000       667,000
Leasehold improvements                                                       139,000       121,000
                                                                         ------------  ------------
                                                                           1,217,000     1,031,000
Less accumulated depreciation and amortization                              (819,000)     (706,000)
                                                                         ------------  ------------
Net property and equipment                                              $    398,000  $    325,000
                                                                         ============  ============

                                                                                December 31,
                                                                         --------------------------
                                                                             2004          2003
                                                                         ------------  ------------              
Intangible product rights.............................................. $  2,456,000  $  2,456,000
Accumulated amortization...............................................   (1,914,000)   (1,844,000)
                                                                         ------------  ------------
                                                                        $    542,000  $    612,000
                                                                         ============  ============

                                                                                December 31,
                                                                         --------------------------
                                                                             2004          2003
                                                                         ------------  ------------              
Accrued royalties...................................................... $    420,000  $    323,000
Accrued annual reports/website expenses................................       81,000       120,000
Accrued pre-clinical trial expenses....................................      133,000            --
Accrued interest payable...............................................       52,000        52,000
Other..................................................................      231,000       136,000
                                                                         ------------  ------------
                                                                        $    917,000  $    631,000
                                                                         ============  ============

                                                                                December 31,
                                                                         --------------------------
                                                                             2004          2003
                                                                         ------------  ------------              
Accrued compensation and employee benefits............................. $    544,000  $         --
Accrued royalties......................................................      500,000       900,000
                                                                         ------------  ------------
                                                                        $  1,044,000  $    900,000
                                                                         ============  ============

                                                                                 Years Ended December 31,
                                                                         ----------------------------------------
                                                                             2004          2003          2002
                                                                         ------------  ------------  ------------
Domestic............................................................... $(17,433,000) $(15,768,000) $ (9,510,000)
Foreign................................................................    4,155,000    10,493,000      (527,000)
                                                                         ------------  ------------  ------------
Loss                                                                    $(13,278,000) $ (5,275,000) $(10,037,000)
                                                                         ============  ============  ============

                                                                                December 31,
                                                                         --------------------------
                                                                             2004          2003
                                                                         ------------  ------------
Assets                                                                                                           
  Net operating loss carryforwards..................................... $ 36,264,000  $ 30,212,000
  R&D credit carryforwards.............................................    5,474,000     5,238,000
  Other................................................................    1,156,000     1,095,000
                                                                         ------------  ------------
Gross deferred tax assets..............................................   42,894,000    36,545,000
Valuation allowance....................................................  (42,894,000)  (36,545,000)
                                                                         ------------  ------------
    Total deferred tax assets.......................................... $         --  $         --
                                                                         ============  ============

                                                                            Shares                     Weighted
                                                                          Available       Number       Average
                                                                             for            of         Exercise
                                                                            Grant         Shares        Price
                                                                         ------------  ------------  ------------
Balances at December 31, 2001..........................................    1,025,869     4,926,857  $       4.86
   1995 Plan shares reserved...........................................    1,350,000            --            --
   Nonemployee Director Plan shares reserved...........................      250,000            --            --
   Options canceled....................................................      349,979      (349,979)         6.67
   Options granted.....................................................     (795,500)      795,500          4.13
   Options exercised...................................................           --      (274,896)         1.87
   Plan shares expired.................................................     (126,542)           --            --
                                                                         ------------  ------------
Balances at December 31, 2002..........................................    2,053,806     5,097,482          4.76
   Options canceled....................................................      345,168      (345,168)         7.43
   Options granted.....................................................   (1,162,034)    1,162,034          6.17
   Options exercised...................................................           --      (380,630)         2.76
   Plan shares expired.................................................      (79,697)           --            --
                                                                         ------------  ------------
Balances at December 31, 2003..........................................    1,157,243     5,533,718          5.02
   2004 Plan shares reserved...........................................    2,500,000            --            --
   2004 Outside Directors Plan shares reserved.........................      465,000            --            --
   Options canceled....................................................      225,955      (225,955)         6.35
   Options granted.....................................................   (1,402,000)    1,402,000          5.05
   Options exercised...................................................           --        (3,150)         3.79
   Plan shares expired.................................................     (269,775)           --            --
                                                                         ------------  ------------
Balances at December 31, 2004..........................................    2,676,423     6,706,613          4.99
                                                                         ============  ============

                        Options Outstanding               Options Exercisable
                   ------------------------------------ ------------------------
                                 Weighted
                                  Average     Weighted                 Weighted
                                 Remaining    Average                  Average
Range of Exercise     Number    Contractual   Exercise     Number      Exercise
      Prices       Outstanding     Life        Price    Exercisable     Price
- ------------------ ------------ -----------  ---------- ------------  ----------
   $1.22 - $2.47     1,214,391        4.09  $     1.68    1,214,391  $     1.68
   $2.67 - $4.25     1,546,416        6.93  $     3.89    1,214,126  $     3.87
   $4.50 - $5.23     1,148,267        7.34  $     4.92      472,250  $     4.85
   $5.25 - $5.83     1,801,614        5.84  $     5.63    1,097,008  $     5.56
   $5.88- $10.75       990,925        4.80  $     9.62      969,029  $     9.68
   $12.50                5,000        5.16  $    12.50        5,000       12.50
                   ------------                         ------------
                     6,706,613        5.88  $     4.99    4,971,804  $     4.94
                   ============                         ============

Options outstanding.....................    6,706,613
Shares available for grant..............    2,676,423
Warrants outstanding....................      904,760
Convertible notes payable...............    1,368,280
ESPP....................................      385,086
                                          ------------
                                           12,041,162
                                          ============

                   Product       Contract
                    Sales        Revenue         Long
                   for the       for the        Lived
                  Year Ended    Year Ended      Assets      Net Assets
                 December 31,  December 31,  December 31,  December 31,
                 ------------  ------------  ------------  ------------
2004:                                                                  
  U.S.......... $         --  $         --  $  1,980,000  $ 26,892,000
  China........   20,174,000            --       283,000    28,014,000
  Other........    2,051,000     1,631,000       211,000       217,000
                 ------------  ------------  ------------  ------------
    Total...... $ 22,225,000  $  1,631,000  $  2,474,000  $ 55,123,000
                 ============  ============  ============  ============
                                                                       
2003:                                                                  
  U.S.......... $         --  $         --  $  2,043,000  $ 45,093,000
  China........   28,078,000            --       213,000    22,928,000
  Other........    3,654,000       806,000       215,000       229,000
                 ------------  ------------  ------------  ------------
    Total...... $ 31,732,000  $    806,000  $  2,471,000  $ 68,250,000
                 ============  ============  ============  ============
                                                                       
2002:                                                                  
  U.S.......... $         --  $         --  $    624,000  $  9,417,000
  China........   15,073,000            --        99,000    13,728,000
  Other........    2,028,000       671,000       234,000       209,000
                 ------------  ------------  ------------  ------------
    Total...... $ 17,101,000  $    671,000  $    957,000  $ 23,354,000
                 ============  ============  ============  ============

                                                                 Three Months Ended
                                               ------------------------------------------------------

                                                March 31,      June 30,    September 30, December 31,
                                               ------------  ------------  ------------  ------------
2004:
Product sales................................ $  5,414,000  $  5,613,000  $  5,753,000  $  5,985,000
Contract revenue.............................      228,000     1,135,000       134,000       134,000
Cost of product sales........................    1,142,000     1,178,000     1,109,000     1,148,000
Gross margin.................................    4,500,000     5,570,000     4,778,000     4,971,000
Net loss.....................................   (3,133,000)   (2,877,000)   (4,913,000)   (2,355,000)
Basic net loss per share.....................        (0.07)        (0.06)        (0.11)        (0.05)
Diluted net loss per share...................        (0.07)        (0.06)        (0.11)        (0.05)

2003:
Product sales................................ $  5,000,000  $ 16,207,000  $  5,421,000  $  5,104,000
Contract revenue.............................      224,000       224,000       224,000       134,000
Cost of product sales........................    1,016,000     2,931,000       935,000       754,000
Gross margin.................................    4,208,000    13,500,000     4,710,000     4,484,000
Net 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)

                                                       Number of      Weighted      Number of shares
                                                      shares to be    average     remaining available
                                                      issued upon     exercise    for future issuance
                                                      exercise of     price of        under equity
                                                      outstanding   outstanding    compensation plans
                                                        options,      options,     (excluding shares
                                                        warrants      warrants        reflected in
                                                       and rights    and rights       column (a))
Plan Category                                             (a)           (b)               (c)
- ----------------------------------------------------  ------------  ------------  --------------------
Equity compensation plans approved by stockholders:
   1991 Stock Plan..................................    1,257,070        4.6982                    --
   1992 Stock Plan..................................       81,500        5.3126                    --
   1995 Equity Incentive Plan.......................    4,479,543        4.8650                22,423
   1995 Nonemployee Director Stock Option Plan......      577,500        6.6239                    --
   1996 Employee Stock Purchase Plan................           --            --               385,086 (1)
   2004 Stock Option Plan...........................       81,000        3.8586             2,419,000
   2004 Outside Directors Stock Option Plan.........      230,000        5.0822               235,000
                                                      ------------                --------------------
Total                                                   6,706,613        4.9859             3,061,509
                                                      ============                ====================

                                                           Balance at    Charged to                  Balance at
                                                          Beginning of    Costs and                    End of
Description                                                  Period       Expenses      Deductions     Period
- --------------------------------------------------------  ------------  -------------  ------------  ----------
Year Ended December 31, 2004                                                                                   
  Reserves and allowances deducted from asset accounts:
     Allowance for uncollectable accounts............... $    638,000  $          --  $    186,000  $  452,000
                                                                                                               
Year Ended December 31, 2003                                                                                   
  Reserves and allowances deducted from asset accounts:
     Allowance for uncollectable accounts............... $    638,000  $          --  $         --  $  638,000
                                                                                                               
Year Ended December 31, 2002                                                                                   
  Reserves and allowances deducted from asset accounts:
     Allowance for uncollectable accounts............... $    638,000  $          --  $         --  $  638,000