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| SCLN > SEC Filings for SCLN > Form 10-K on 13-Mar-2009 | All Recent SEC Filings |
13-Mar-2009
Annual Report
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the "Selected 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.
Overview
SciClone Pharmaceuticals (NASDAQ: SCLN) is a for-profit, global pharmaceutical
company with a substantial international business and a product portfolio of
novel therapies for cancer and infectious diseases. Our objective, which we
believe we will achieve, is sustained profitability for the full year 2009
through a combination of international sales growth, a cost-containing clinical
development strategy, and focused expense management. ZADAXIN ®, our brand of
thymalfasin and our primary product, is sold in over 30 countries for the
treatment of the hepatitis B virus (HBV) and the hepatitis C virus (HCV),
certain cancers and as a vaccine adjuvant. Our cash position and the profit
margin on our product sales and marketing operations provide the financial
resources for continued growth in our international business and for development
of our pipeline of phase 2 drug candidates, including: RP101 for the treatment
of pancreatic cancer and SCV-07 for the treatment of HCV and for oral mucositis.
Our DC Bead product is awaiting approval in the Peoples Republic of China
(China), for the treatment of liver cancer.
We plan to expand our commercial operations, currently primarily located in China, with the goal of becoming a significant pharmaceutical company in this rapidly growing market. A key part of our strategy is to leverage our decade of experience in China and to grow our international business by adding commercial stage or near term commercial stage products to our portfolio. For example, after acquiring the Chinese marketing rights to DC BeadTM for liver cancer, we are pursuing its regulatory approval and, if approved, intend to launch this product in 2009. We believe we are well-positioned to in-license additional therapeutics for our international business with a focus on China, in part because of our opportunity to develop and commercialize these products utilizing our well established sales and marketing organization in China.
For the years ended December 31, 2008, 2007, and 2006 product sales were $54,108,000, $37,038,000 and $32,433,000, respectively. Our revenue growth was attributable to further market penetration in China related to ZADAXIN. For the years ended December 31, 2008, 2007, and 2006 product sales to China were $50,724,000, $34,240,000 and $29,722,000, respectively.
SciClone continues its clinical development program potential with three product candidates being studied in four indications. Our latest stage opportunity is ready for phase 3 which will evaluate thymalfasin as a therapy for stage IV melanoma. We estimate that this is a $200 million market opportunity worldwide. If the targeted patient group can be extended to the adjuvant setting through additional clinical trials, we believe the global market opportunity could increase by about $500 million. We are in the process of seeking a partner for this phase 3 trial prior to initiating enrollment.
In June 2007, we reported positive data from a phase 2 trial, conducted in partnership with Sigma-Tau, treating patients with stage IV melanoma in which we showed that thymalfasin in combination with dacarbazine (DTIC) chemotherapy and low dose interferon alpha met its primary endpoint. Further, two of the thymalfasin treated groups had an overall response rate three times higher than stage IV melanoma patients treated with DTIC, the current standard of care, and low dose interferon alpha. In addition, survival, a key secondary endpoint of the trial, was extended by nearly 3 months. In November 2008, we reported that we reached an agreement on Special Protocol Assessment with the U.S. Food and Drug Administration (FDA) on the design of a phase 3 registration trial for thymalfasin as a potential treatment for stage IV melanoma that adequately addresses the objectives necessary to support a regulatory submission.
In addition to thymalfasin, we are developing RP101 and SCV-07 for the treatment of life-threatening diseases. We are conducting a multi-center, randomized, double-blinded, placebo controlled phase 2 clinical trial using RP101 in combination with gemcitabine chemotherapy in approximately 153 patients with unresectable stage III and IV pancreatic cancer. We announced March 9, 2009 that we completed enrollment of this trial ahead of schedule and expect to report results in the first half of 2010.
In September 2008, we reported what we believe are promising results from our proof-of-concept phase 2a clinical trial using SCV-07 as a sole agent administered to patients chronically infected with HCV. The trial was designed to evaluate the effect of SCV-07 on hepatitis C viral load, as well as on other measures of immune response. SCV-07 demonstrated activity in some treated patients in the higher dosage groups, and the decrease in viral load in these patients was accompanied by an increase in a biomarker which is usually correlated with an immunological response against HCV. Additionally, SCV-07 was shown to be generally safe and well-tolerated with no dose limiting toxicities or serious adverse events reported. We are planning to initiate a phase 2b trial for SCV-07 in HCV in 2009.
During the fourth quarter of 2008, SCV-07 also entered phase 2 clinical development to assess the safety and efficacy of SCV-07 for the delay to onset of severe oral mucositis in subjects receiving chemoradiation therapy for the treatment of cancers of the head and neck. In this multi-center, randomized, double-blind, placebo-controlled dose-ranging study, we plan to enroll approximately 60 patients and expect to complete enrollment of this trial before the end of 2009.
We manufacture ZADAXIN, RP101 and SCV-07 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.
We believe our cash on hand and ongoing business operations and $6 million line of credit will be sufficient to fund current business activities for the foreseeable future. During this period, we may report quarterly losses. Our ability to sustain operating profitability will be impacted by numerous factors including expansion of our sales efforts for ZADAXIN, the regulatory approval process including the timing of FDA or international regulatory approvals, the number, timing, costs and results of pre-clinical and clinical trials of our products, market acceptance of ZADAXIN, and potentially of SCV-07, DC Bead, and RP101, the timing of orders for ZADAXIN from international markets, particularly China, and the acquisition of additional product rights and the funding, if any, provided as a result of corporate partnering arrangements.
Critical Accounting Policies and Estimates
General
We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations" where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the "Notes to our Consolidated Financial Statements" in Part II, Item 8 of this Annual Report on Form 10-K. Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United Sates, which requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. On an on-going basis, we evaluate the relevance of our estimates. We base our estimates on historical experience and on various other market specific assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from those estimates.
Revenue Recognition
We recognize revenue from product sales at the time of delivery. There are no significant customer acceptance requirements or post-shipment obligations on our part, except for sales to a new market where acceptance requirements have to be met. Sales to importing agents or distributors are recognized at time of shipment when title to the product is transferred to them. Importing agents or distributors do not have contractual rights of return except under limited terms regarding product quality. However, we are expected to replace products that have expired or are deemed to be damaged or defective when delivered. We estimate expected returns primarily on historical patterns. Historically, we have had no product returns of damaged, defective or expired product. As such, no amount was accrued for product returns as of December 31, 2008 and 2007 in the respective consolidated balance sheets. Payments by the importing agents and distributors are not contingent upon sale to the end user by the importing agents or distributors.
Amounts invoiced relating to arrangements where collectibility is uncertain and revenue cannot be recognized are reflected on our balance sheet as deferred revenue and recognized as the applicable revenue recognition criteria are satisfied.
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.
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.
Cash Equivalents and Investments
Cash equivalents consist of highly liquid investments with maturities of three months or less on the date of purchase. We classify our investment portfolio as available-for-sale or trading securities. We record the investments at fair value, on the balance sheet.
Unrealized gains or losses on available-for-sale securities are included in accumulated other comprehensive income on the consolidated balance sheet. Realized gains or losses on available-for-sale and trading securities and declines in value judged to be other than temporary on available-for-sale securities are determined on the basis of specific identification and included in other income (expense).
We evaluate our investments for impairment each reporting period in accordance with FSP FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (FSP FAS 115-1). FSP FAS 115-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. If, after consideration of all available evidence to evaluate the realizable value of its investment, impairment is determined to be other-than-temporary, then an impairment loss is recognized in the Consolidated Statement of Operations equal to the difference between the investment's cost and its fair value.
Fair Value of Financial Instruments
We adopted the provisions of the Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurements" (SFAS No. 157), effective January 1, 2008. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157", which provides a one year deferral
of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, we deferred adoption of SFAS 157 as it relates to its non financial assets and liabilities. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements.
Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs.
The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value. Our assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy. The three levels of input are:
Level 1-Quoted prices in active markets for identical assets or liabilities.
Level 2-Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The adoption of this statement did not have a material impact on our consolidated results of operations and financial condition.
Effective January 1, 2008, we also adopted SFAS No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities" (SFAS 159). SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. We elected to adopt the fair value accounting under SFAS 159 at the initial recognition of a put option from UBS AG with respect to our auction rate securities (ARS) recorded in other assets in our consolidated balance sheet.
Following is a description of our valuation methodologies for assets and liabilities measured at fair value.
Where quoted prices are available in an active market, fair value is based upon quoted market prices, and are classified in level 1 of the valuation hierarchy. Level 1 securities include our money market funds, U.S. term deposits, corporate equity securities and restricted long-term Italian state bonds. If quoted market price are not available, fair value is based upon observable inputs such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities and are classified in level 2 of the valuation hierarchy. Level 2 securities include our certificate of deposit. When quoted prices and observable inputs are unavailable, fair values are based on internally developed cash flow models and are classified in level 3 of the valuation hierarchy. The internally developed cash flow models primarily use, as inputs, estimates for interest rates and discount rates including yields of comparable traded instruments adjusted for illiquidity and other risk factors, amount of cash flows and expected holding periods of the assets. These inputs reflect our own assumptions about the assumptions market participants would use in pricing the assets including assumptions about risk developed based on the best information available in the circumstances. Level 3 securities include our ARS and the Put Option with respect to these securities.
Other financial instruments, including accounts receivable, accounts payable and accrued liabilities, are carried at cost, which we believe approximates fair value because of the short-term maturity of these instruments.
Accounts Receivable
We are required to estimate the collectibility of our trade receivables. We maintain reserves for credit losses, and such losses have been within our expectations. We recognize reserves for bad debts ranging from 25% to 100% of past due accounts receivable based on the length of time the receivables are past due and our collectibility experience. A considerable amount of judgment is required in assessing the ultimate realization of these receivables including, but not limited to, an analysis of the historical payment patterns of our customers, the circumstances of each individual customer 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.
Inventories
Our inventories are stated at the lower of cost or market, with cost determined on a first-in, first-out basis. 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. If our current assumptions about future production or inventory levels and demand were to change or if actual market conditions are less favorable than those projected by management, inventory write-downs may be required which could negatively impact our gross margins and results of operations. If obsolete items are observed and there are no alternate uses for the inventory, we will record a write-down to net realizable value in the period that the impairment is first recognized.
Intangible Assets
At December 31, 2008, we had net intangible assets of approximately $262,000 related to ZADAXIN product rights and have not recorded any impairment losses to-date related to intangible assets. In assessing the recoverability of our intangible assets we must make assumptions regarding estimated future cash flows and other factors. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets.
Research and Development Expenses
Effective January 1, 2008, we adopted Emerging Issues Task Force (EITF) Issue No. 07-3 "Accounting for Nonrefundable Advance Payments for Goods or Services to be used in Future Research and Development Activities" (EITF 07-3). In accordance with EITF 07-3, nonrefundable advance payments for goods or services to be received in the future for use in research and development activities should be deferred and capitalized. The capitalized amounts should be expensed as the related goods are delivered or the services are performed. The adoption did not have a material impact on our consolidated results of operations or financial condition.
Our research and development expenses are principally incurred for our clinical trials including cost sharing of Sigma-Tau's clinical trial in Europe using ZADAXIN as part of a novel triple therapy combination for the treatment of HCV, our phase 2 clinical trials for RP101 and SCV-07, and our development plans for a phase 3 clinical trial for melanoma. Research and development expenses are charged to operations as incurred. 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 to the actual services received and efforts expended. Expenses related to grants to the institutions that conduct the clinical trials on our behalf are accrued based on the level of patient enrollment and activity according to the protocol. Expenses relating to the clinical research organization 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. If we underestimate or overestimate the activity associated with a study or service at a given point in time, adjustments to research and development expenses may be necessary in future periods. We monitor active patient enrollment levels and related activity to the extent possible and adjust our estimates accordingly.
Stock Option Valuation
We apply Statement of Financial Accounting Standards (FAS) No. 123(R), "Share-Based Payment" (FAS 123R), for stock-based payment transactions in which we receive employee services in exchange for our equity instruments. Employee stock-based compensation is estimated at the date of grant based on the employee stock award's fair value using the Black-Scholes option-pricing model and is recognized as expense ratably over the requisite service period, which is generally four years. The Black-Scholes option-pricing model requires the use of certain subjective assumptions. The most significant of these assumptions are our estimate of the expected volatility of the market price of its stock and the expected term of the award. When establishing an estimate of the expected term of an award, we consider the vesting period for the award, recent historical experience of employee stock option exercises (including forfeitures), and the expected volatility. As required under the accounting rules, we review our valuation assumptions at each grant date, and, as a result, valuation assumptions used to value employee stock-based awards granted in future periods may change.
We have not recognized, and do not expect to recognize in the near future, any tax benefit related to employee stock-based compensation cost.
Results of Operations
Product sales were $54,108,000, $37,038,000, and $32,433,000 for the years ended December 31, 2008, 2007, and 2006, respectively, and all were derived from sales of ZADAXIN. The increases from 2006 to 2008 were attributable to a higher volume of product sold primarily due to continued expansion of our sales and marketing efforts and a modest increase in prices from the 2007 to 2008 periods. Sales to customers in China are denominated in U.S. dollars and accounted for approximately 94%, 92%, and 92% of this revenue for the years ended December 31, 2008, 2007 and 2006, respectively.
For the years ended December 31, 2008, 2007, and 2006, sales in each year to three or four importing agents in China accounted for approximately 94%, 92%, and 92%, respectively of our product sales. In 2008, Shanghai Lingyun and China National Pharmaceutical Foreign Trade Corporation accounted for 68% and 22% of our sales, respectively, and one other importer accounted for 4% of our sales. In 2007, Shanghai Lingyun and China National Pharmaceutical Foreign Trade Corporation accounted for 63% and 21% of our sales, respectively, and one other importer accounted for 8% of our sales. In 2006, Shanghai Lingyun and China National Pharmaceutical Foreign Trade Corporation accounted for 66% and 15% of our sales, respectively, and two others accounted for a combined 11%. No other customers accounted for more than 10% of sales in those periods. As of December 31, 2008, approximately $11,420,000 or 96% of our accounts receivable were attributable to two 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 $5,000, $20,000, and $229,000 for the years ended December 31, 2008, 2007, and 2006, respectively. During 2008 and 2007, we recognized $5,000 and $20,000, respectively, in contract revenue for a partial license fee for ZADAXIN from a third party. There was no similar revenue for the year ended
December 31, 2006. Contract revenue recognized in 2006 was in connection with the $2,685,000 payment we received from Sigma-Tau in January 2002 and a $50,000 payment we received from Sigma-Tau in December 2006. This revenue was recognized as contract revenue over the course of the ZADAXIN HCV U.S. clinical program and the period of sharing the clinical data from this program with Sigma-Tau in accordance with the performance requirements under our contract with Sigma-Tau.
Gross margin was 82%, 82%, and 79% in 2008, 2007, and 2006, respectively. The decrease in gross margin in 2006 was primarily due to an increase of $929,000 in royalty expense recorded in December 2006 related to an agreement with Wayne State University (WSU) regarding royalty obligations for the period 1997 to 2006. We expect cost of product sales and hence gross margin to vary from year to year, depending upon the level of ZADAXIN sales, the absorption of product-related fixed costs, and any charges associated with excess or expiring finished product inventory.
Research and development (R&D) expenses were $23,537,000, $17,446,000, and $14,088,000 and represented approximately 45%, 42%, and 41% of our total operating costs and expenses for the years ended December 31, 2008, 2007, and 2006, respectively. The increase of $6,091,000 in R&D expenses from 2007 to 2008 related to our phase 2 clinical trials for RP101 and SCV-07, and to the development planning for a phase 3 clinical trial for melanoma. The increase included approximately $2,002,000 for clinical trial management, statistical services and investigator expenses; an increase of approximately $2,659,000 for drug development and manufacturing costs related to the scale up for RP-101 and purchase of gemcitabine for the RP101 clinical trial, and manufacturing of SCV-07 and ribavirin for the SCV-07 clinical trial; a $1,320,000 milestone payment upon first patient dosing in the RP101 phase 2 clinical trial; an . . .
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