Quarterly Report

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

The following material contains certain forward-looking statements including statements regarding the application of ZADAXIN(R) thymosin alpha 1 in disease areas beyond hepatitis B, the potential for regulatory approvals of ZADAXIN and the launching of ZADAXIN in additional markets, and the Company's expectations regarding increases in revenues from ZADAXIN and increases in marketing and research and development expense levels. These statements are subject to certain risks and uncertainties. These risks and uncertainties include the Company's current reliance on a single product, ZADAXIN , for its revenues, the absence of regulatory approval for ZADAXIN in significant markets, the expensive, time consuming and uncertain regulatory approval process, risks associated with the manufacture and supply of ZADAXIN, competition from competing therapies, and uncertainties regarding the outcome of the Company's efforts to commercialize additional products, as well as other risks and uncertainties described herein and in the Company's other reports filed with the Securities and Exchange Commission.

The Company is an international biopharmaceutical company involved in the acquisition, development and commercialization of pharmaceuticals worldwide. The Company focuses on specialist oriented products that address significantly unmet chronic or life-threatening diseases. The Company concentrates on infectious diseases, cancer, immune system disorders, and cystic fibrosis. Currently, the Company has acquired two drugs for development and commercialization: ZADAXIN for hepatitis B and C, cancer and immune system disorders; and CPX for cystic fibrosis. To date, the Company's principal focus has been the development and commercialization of ZADAXIN.

From commencement of operations through March 31, 1997, the Company incurred a cumulative net loss of approximately $74.4 million. The Company expects its operating expenses to increase over the next several years as it expands its research and development, clinical testing and marketing capabilities. The Company's ability to achieve profitable operations is primarily dependent on securing regulatory approvals for ZADAXIN in additional countries, successfully launching ZADAXIN if approved in such countries and meeting increased demand for ZADAXIN, if it arises. In addition, other factors may also impact the Company's ability to achieve a profitable level of operations such as spending associated with the successful development of CPX, acquiring rights to additional drugs, and entering into and extending agreements for product development and commercialization, where appropriate. There can be no assurance that the Company will be able to attain these objectives or that the Company will ever achieve a profitable level of operations.

The Company's operating results may fluctuate from period to period as a result of, among other things, the timing and costs associated with clinical trials and the regulatory approval process, and the acquisition of additional product rights. The Company participates in a highly dynamic industry, which often results in significant volatility of the Company's common stock price. Setbacks in clinical trials, in the regulatory approval process or in relationships with collaborative partners, and any shortfalls in revenue or earnings from levels expected by securities analysts, among other developments, have in the past had and could in the future have an immediate and significant adverse effect on the trading price of the Company's common stock in any given period.

Results of Operations

Product sales were approximately $671,000 and $126,000 for the three-month periods ended March 31, 1997 and 1996, respectively. Currently, the Company has received approval to market ZADAXIN in China, the Philippines and Singapore and commercially launched ZADAXIN during the first quarter of 1997. In addition, the Company has filed for approval to market ZADAXIN in several countries and anticipates additional filings in other countries. As a result, the Company expects product sales to increase in 1997 and beyond, as a result of the commercial launch of ZADAXIN in its existing approved markets and upon the commencement of the commercial launch of ZADAXIN in additional markets once regulatory approvals are secured. The level of such product sales increase is dependent upon additional ZADAXIN marketing approvals and successfully launching ZADAXIN. Although the Company remains optimistic regarding the prospects of ZADAXIN, there can be no assurance that the Company will achieve significant levels of product sales.

Cost of product sales was approximately $262,000 and $200,000 for the three-month periods ended March 31, 1997 and 1996, respectively. The increase is attributable to increased product sales. The Company expects cost of product sales to vary from quarter to quarter, dependent upon the level of product sales and the absorption of fixed product-related costs.

Research and development expenses were approximately $2,066,000 and $2,535,000 for the three-month periods ended March 31, 1997 and 1996, respectively. The decrease is primarily attributable to decreased clinical expenses associated with completion of the ZADAXIN clinical trial in Taiwan in early 1996 and decreased personnel costs associated with reduced headcount. Clinical expenses in the 1997 period were impacted by additional preclinical development and clinical trial expenses for the clinical development of CPX, a synthetic compound licensed in April 1996 from the National Institutes of Health as a potential treatment for cystic fibrosis. In April 1997, CPX entered a Phase I clinical trial in the United States. In addition, the Company is organizing its U.S. and European ZADAXIN clinical trial strategy and expects clinical trials to start later this year. The initiation of these trials will have a significant effect on the Company's research and development expenses in the future. In general,the Company expects research and development expenses to increase over the next several years and to vary quarter to quarter as the Company pursues its strategy of initiating additional clinical trials and testing, acquiring product rights, and expanding regulatory activities.

Marketing expenses were approximately $1,029,000 and $1,071,000 for the three-month periods ended March 31, 1997 and 1996, respectively. The decrease is primarily attributable to decreased professional services partially offset by increased promotional material expenses associated with the launch of ZADAXIN in its approved markets during the first quarter of 1997. The Company expects marketing expenses to increase significantly in the next several quarters and years as it anticipates expanding its commercialization and marketing efforts and pursuing other strategic relationships.

General and administrative expenses were approximately $867,000 and $776,000 for the three-month periods ended March 31, 1997 and 1996, respectively. The increase is primarily attributable to increased general office expenses associated with increased rent and office relocation expenses. In the near term, the Company expects general and administrative expenses to vary quarter to quarter as the Company augments its general and administrative activities to support increased expenditures on clinical trials and testing, and regulatory, pre-commercialization and marketing activities.

Net interest and investment income was approximately $513,000 and $716,000 for the three-month periods ended March 31, 1997 and 1996, respectively. The decrease primarily resulted from decreased interest and investment income due to lower average invested cash balances.

Liquidity and Capital Resources

At March 31, 1997, the Company had approximately $30,806,000 in cash, cash equivalents and highly liquid short and long-term investments.

Net cash used by the Company in operating activities amounted to approximately $4,265,000 for the three-month periods ended March 31, 1997. Net cash used in operating activities in the 1997 period is greater than the Company's net loss for such period primarily due to increases in accounts receivable associated with sales from the Company's launch of ZADAXIN in its approved markets and increases in payments to third parties for goods and services and to employees for compensation and benefits. These uses of cash were offset by noncash charges associated with depreciation and amortization and increases in amounts owed to third parties for clinical trials. Net cash used in operating activities amounted to approximately $4,135,000 for the three-month period ended March 31, 1996. Net cash used in operating activities in the 1996 period is greater than the Company's net loss for such period primarily due to cash used for inventory purchases, the prepayment of certain future period expenses and decreases in amounts owed to third parties for goods and services related to clinical trial expenses and compensation and benefits. These uses were offset by increases in amounts owed for accrued professional fees and noncash charges associated with depreciation and amortization.

Net cash provided by investing activities for the three-month periods ended March 31, 1997 related to the net sale of approximately $2,922,000 of marketable securities offset by the purchase of $40,000 in equipment and furniture. Net cash provided by investing activities for the comparable 1996 period primarily resulted from the net sale of $1,735,000 of marketable securities offset by the purchase of $46,000 of equipment and furniture.

Net cash provided by financing activities for the three-month periods ending March 31, 1997 primarily consisted of approximately $1,025,000 in proceeds received from the issuance of common stock from the exercise of outstanding warrants and under the Company's stock option plan, offset by repurchases of the Company's common stock under the Company's approved stock repurchase plan of approximately $826,000. Net cash provided by financing activities for the three-month period ending March 31, 1996 related to approximately $2,352,000 in proceeds received from issuance of common stock under the Company's stock option plan.

Management believes its existing capital resources and interest on funds available are adequate to maintain its current and planned operations at least through 1998. However, the Company's capital requirements may change depending upon numerous factors, including the level of ZADAXIN product sales, the availability of complementary products, technologies and businesses, the initiation of clinical trials and testing, the timing of regulatory approvals, developments in relationships with collaborative partners and the status of competitive products. If the Company cannot eventually generate sufficient funds from operations, it will need to raise additional financing. There can be no assurance that such financing will be available on acceptable terms, or at all.