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SCLN > SEC Filings for SCLN > Form 10-Q on 9-Nov-2011All Recent SEC Filings

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Form 10-Q for SCICLONE PHARMACEUTICALS INC


9-Nov-2011

Quarterly Report


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

Special Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based on our current expectations, estimates and projections about our business, industry, management's beliefs and certain assumptions made by us. Words such as "anticipate," "expect," "intend," "plan," "believe" or similar expressions are intended to identify forward-looking statements including those statements we make regarding our future financial results; anticipated product sales; the sufficiency of our resources to complete clinical trials and other new product development initiatives; the findings of our Special Committee and remedial measures we are taking or plan to take, government regulatory actions that may affect product reimbursement, product pricing or otherwise affect the scope of our sales and marketing; the timing and outcome of clinical trials; the timing of completion of therapy and observation for our clinical trials; ZADAXIN®'s ability to complement existing therapies; prospects for ZADAXIN and our plans for its enhancement and commercialization; future size of the worldwide hepatitis B virus ("HBV") and hepatitis C virus ("HCV") and other markets; research and development and other expense levels; the ability of our suppliers to continue financially viable production of our products; cash and other asset levels; the allocation of financial resources to certain trials and programs, and expenses related to litigation and regulatory investigations. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors including, but not limited to, those described under the caption "Risk Factors" in this Quarterly Report on Form 10-Q. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Overview

SciClone Pharmaceuticals (NASDAQ: SCLN) is a revenue-generating, profitable, China-centric, specialty pharmaceutical company with a substantial commercial business and a product portfolio of therapies for oncology, infectious diseases and cardiovascular, urological, respiratory, and central nervous system disorders. We are focused on continuing international sales growth through our strong sales and marketing efforts, and growing our profitability, while containing our United States-based clinical development costs by limiting this effort to the current SCV-07 phase 2b clinical program in oral mucositis, with the expectation that a partner would fund any future trials for SCV-07. Our business and corporate strategy is focused primarily on the People's Republic of China ("China") where we have built a solid reputation and established a strong brand through our many years of experience marketing our lead product, ZADAXIN. We believe our strengths position us to benefit from expanding pharmaceutical markets in China. We believe China will rank second among global pharmaceutical markets by 2016, with projected annual growth rates of 18-20% or more annually over the next several years. We seek to grow sales of our current product portfolio in the region while we leverage our strong balance sheet for future acquisitions and product in-licensing.

We acquired NovaMed Pharmaceuticals, Inc. ("NovaMed") on April 18, 2011, and our results of operations include the operations of NovaMed as of that date forward. We believe the NovaMed acquisition positions us as a leading specialty pharmaceutical company in China, with key pharmaceutical assets, new therapeutic areas of focus, and an expanded management team, including a combined sales force of over 680 professionals. We aim to expand our presence in China by increasing revenues from our key products, by in-licensing additional products, and by expanding our sales force to further penetrate the market. Our portfolio now has 17 marketed products and spans major therapeutic areas including oncology, infectious diseases, and cardiovascular, urological, respiratory and central nervous system disorders. The acquisition expanded our portfolio of commercial and development stage products through exclusive licensing and promotion agreements with a number of leading pharmaceutical companies.

We have two categories of revenues: those generating "product sales revenues" and those generating "promotion services revenues". Our product sales revenues result from our proprietary and in-licensed products, including our lead product, ZADAXIN, and products from Pfizer Inc. and Iroko Pharmaceuticals LLC. Our flagship product, ZADAXIN, has the highest margins in our portfolio as it is a premium proprietary product sold exclusively by SciClone. Aggrastat®, an in-licensed product which we began selling more recently in China, also has higher margins than our promoted products and we expect that revenues from this product will grow significantly as it further penetrates the China market. In addition, we anticipate that new marketed products, when introduced, such as DC Bead ®, Tramadol®, and ondansetron RapidFilm®will increase our future revenues and profitability of our growing pharmaceutical business in China over the coming years.

Our "promotion services revenues" result from fees we receive for exclusively promoting products from certain partners including Sanofi S.A. and Baxter International, Inc. in China. We recognize promotion services revenues as a percentage of our collaborators' product sales revenue for our exclusively promoted products such as Depakine®, Stilnox®, and Tritace ®. Over time, as additional proprietary or in-licensed products come to the market, we expect our product mix will shift to higher margin products.


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SciClone's ZADAXIN (thymalfasin) is approved in over 30 countries and may be used for the treatment of hepatitis B (HBV), hepatitis C (HCV), as a vaccine adjuvant, and certain cancers according to the approvals we have in these countries. To continue to grow ZADAXIN sales to China, our sales force is focused on increasing sales to the country's largest hospitals (class 3 with over 500 beds) as well as smaller hospitals (class 2). These hospitals serve Tier 1 and Tier 2 cities located mostly in the eastern part of the nation which are the largest and generally have the most affluent populations in China. ZADAXIN's list price in China is currently under review by regulatory authorities. We anticipate that a price reduction may occur, and if a substantial reduction in the list price occurred, our revenues and gross margins for ZADAXIN would be substantially reduced.

SciClone's marketed portfolio also includes Depakine, the most widely prescribed broad-spectrum anti-convulsant in China; Tritace, an ACE inhibitor for the treatment of hypertension; Stilnox, a fast-acting hypnotic for the short-term treatment of insomnia (marketed as Ambien ® in the US); and Aggrastat, an intervention cardiology product launched in 2009. SciClone is also pursuing the registration of several other therapeutic products in China.

We continue to look for in-licensing opportunities for China of late-stage or approved branded, well-differentiated products that if not yet approved have a clear regulatory pathway in China based on existing approval outside of China. Our preference is on in licensing products for our product sales revenues category and we continue to explore opportunities to optimize our promotion services revenues category. We are also working on the final stage of the regulatory approval in China for our in-licensed candidate DC Bead, and on the approval process for our other product candidates, all of which are in clinical trials or in other stages of the regulatory approval process in China.

We are currently developing SCV-07, a small molecule synthetic peptide with immunomodulating properties, in a phase 2b clinical trial for the prevention of oral mucositis ("OM"). OM is a common, painful, debilitating complication of cancer treatment, and we estimate that medical costs for the treatment of oral mucositis were approximately $4.2 billion in the U.S. and $10 billion worldwide in 2010. We announced the enrollment of the first patient in the Company's phase 2b clinical trial of SCV-07 for the delay of onset of OM in January of 2011. The current phase 2b clinical trial is a multicenter, randomized, double-blind, placebo-controlled study designed to enroll approximately 160 patients, who are receiving standard chemoradiation therapy for treatment of cancers of the head and neck, to assess the drug's ability to modify the course of OM. The study will evaluate three doses of SCV-07 (0.1 mg/kg, 0.3 mg/kg and 1 mg/kg), including two higher doses than those used in the previous phase 2a study. The study's primary efficacy endpoint is the reduction in the proportions of patients with clinically assessed ulcerative OM (WHO Grade ³ 2) at the time that they have received a cumulative radiation dose of 45 Gy. The study's secondary endpoints include incidence and duration of ulcerative and severe (WHO Grade ³
3) OM, analgesic use and pain assessments, quality of life measurements, gastrostomy tube placement and use, breaks in radiation or chemotherapy treatment, and unscheduled office or hospital visits.

In October 2011, we announced a preliminary settlement of stockholder derivative litigation. The proposed settlement terms provide for the actions against the defendants to be dismissed with prejudice and for the release of certain known or unknown claims that have been or could have been brought later in court arising out of the same allegations. We agreed that if the proposed settlement terms are approved, we will adopt certain corporate governance measures, to be in effect for at least three years, and have agreed to the payment of approximately $2.5 million in attorney's fees to counsel for the plaintiffs, with $2.5 million to be paid by our insurers under our director and officer liability policy, subject to approval by the Court. The settlement is subject to final approval by the Court and a settlement hearing is currently scheduled for December 13, 2011.

The United States Securities and Exchange Commission ("SEC") and the United States Department of Justice ("DOJ") are each conducting formal investigations of us regarding a range of matters including the possibility of violations of the Foreign Corrupt Practices Act ("FCPA"). We will continue to cooperate fully with the SEC and DOJ in the conduct of their investigations. In response to these matters, our Board appointed a Special Committee of independent directors (the "Special Committee") to oversee our response to the government inquiry. The Special Committee has substantially concluded its investigation and on May 4 and 5, 2011 reported its findings and recommendations to the Board of Directors. As part of its continuing cooperation with the ongoing investigation of the SEC and the DOJ, the Special Committee has also reported findings to the SEC and DOJ. The SEC's and DOJ's formal investigations are continuing. These continuing investigations could result in administrative orders against us, the imposition of significant penalties and/or fines against us, and/or the imposition of civil or criminal sanctions against us or certain of our officers, directors and/or employees. We cannot predict what the outcome of those investigations will be, or the timing of any resolution. Refer to Footnote 10 "Other Corporate Matters",

Part II, Item 1. "Legal Proceedings" and to Part I, Item 4 "Changes in Internal
Controls" in this Form 10-Q for further information regarding the investigation and remedial measures, related litigation, and the material weaknesses we have identified.


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Critical Accounting Estimates and Assumptions

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make judgments, estimates and assumptions in the preparation of our condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Business Combinations

We accounted for the acquisition of NovaMed in April 2011 in accordance with ASC Topic 805, Business Combinations. ASC Topic 805 establishes principles and requirements for recognizing and measuring the total consideration transferred to and the assets acquired and liabilities assumed in the acquired target in a business combination. The consideration paid to acquire NovaMed is required to be measured at fair value and included contingent consideration, which are earn-out payments that will be paid upon the successful achievement of revenue and earnings targets for the 2011 and 2012 fiscal years. After the total consideration transferred was calculated by determining the fair value of the contingent consideration and SciClone common stock, plus the cash consideration, we assigned the purchase price of NovaMed to the fair value assets acquired and liabilities assumed. This resulted in recognition of intangible assets related to promotion and distribution contract rights and goodwill. The determination and allocation of the consideration transferred requires management to make significant estimates and assumptions, especially at the acquisition date with respect to the fair value of the contingent consideration and intangible assets acquired.

As part of the acquisition of NovaMed, we may be required to pay up to $43.0 million in contingent consideration upon the successful achievement of revenue and earnings targets for the 2011 and 2012 fiscal years. As of September 30, 2011, we have estimated the fair value of the contingent consideration to be $17.4 million. We estimated the fair value of the contingent consideration on the acquisition date using a Monte Carlo simulation model. The earn-out is based upon certain financial performance metrics, including a revenue-based formula and an adjusted EBITDA (earnings before interest, depreciation and taxes) based formula. The earn-out provisions are subject to a number of adjustments and acceleration provisions. The total earn-out payments described above may be increased by $10.0 million (but not exceeding a total maximum contingent cash consideration of $43.0 million) or reduced by $10.0 million, depending upon whether we are able to achieve targets relating to product distribution agreements. If there is a change-in-control of the Company on or before April 18, 2012, then the earn-out payment would be deemed to be $23.0 million. If there is a change-in-control of the Company on or after April 18, 2012 and before December 31, 2012, then the earn-out payment would range between $11.5 million and $23.0 million depending upon achievement against the adjusted EBITDA and revenue targets through the date of the change-in-control. In addition, if either (i) Mark Lotter is terminated without cause prior to December 31, 2012, or (ii) if we fail to meet certain obligations to appoint and retain Mark Lotter and Peter Barrett (or their replacements) on our Board of Directors through December 31, 2012, the earn-out payment would be deemed to be $23.0 million. We are required to remeasure the contingent consideration each reporting period until the amount of the payment is finalized, which may not occur until December 31, 2012. The change in the estimated fair value of the contingent consideration is recognized as an adjustment to operating expenses. From the acquisition date of April 18, 2011 to September 30, 2011, the estimated fair value of the contingent consideration decreased by $1.4 million primarily as a result of adjustments to certain performance metric projections used to estimate the fair value. Future changes in the estimated fair value of the contingent consideration may be significant, as the ultimate contingent consideration payout could range from $0 to $43.0 million.

Goodwill and Other Intangible Assets

We account for goodwill and other intangible assets in accordance with ASC Topic 805, and ASC Topic 350, Intangibles - Goodwill and Other. ASC Topic 805 requires that the purchase method of accounting be used for all business combinations and specifies the criteria that must be met in order for intangible assets acquired in a business combination to be recognized and reported apart from goodwill. As of September 30, 2011, we have recognized from the acquisition $47.1 million of intangible assets related to promotion and distribution relationships and $31.6 million of goodwill. Our intangible assets are amortized over 13.5 years, based on their estimated useful life, and goodwill is determined to have an indefinite life and therefore, is not amortized. Intangible assets and goodwill are tested for impairment at least annually or whenever events or circumstances occur that indicate impairment might have occurred in accordance with ASC Topic 350. Judgment regarding the existence of impairment indicators will be based on operating results, changes in the manner of our use of the acquired assets or our overall business strategy, and market and economic trends. In the future, events such as the loss of promotion and distribution contracts could cause us to conclude that impairment indicators exist and that certain intangibles and other long-lived assets are impaired resulting in an adverse impact on our financial position and results of operations.


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Product Sales Allowance

Revenue from product sales is recorded net of an allowance for product returns established at the time of sale. The allowance for product returns is based on estimates of the amount of product to be returned by our customers which may result from expired product or for price reductions on the related sales and is based on historical patterns, analysis of market demand and/or a percentage of sales based on industry trends, and management's evaluation of specific factors that may increase the risk of product returns. The calculation of the product returns allowance requires estimates and involves a high degree of subjectivity and judgment. As a result of the uncertainties involved in estimating the product returns allowance, there is a possibility that materially different amounts could be reported under different conditions or using different assumptions. As of September 30, 2011, we have estimated a product returns allowance of $0.1 million on our Condensed Consolidated Balance Sheet, related to our oncology products and Aggrastat product sales. We evaluate our returns allowance quarterly and adjust it when events indicate that a change in estimate is appropriate. Such changes in estimate could materially affect our results of operations or financial position; however, to date they have not been material. It is possible that we may need to adjust our estimates in future periods.

We believe there have been no other significant changes in our critical accounting policies discussed in our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC on March 31, 2011.

Results of Operations

Revenues and Cost of Product Sales:

The following table summarizes the period over period changes in our product
sales and promotion services (in thousands):



                         Three Months Ended                       Nine Months Ended
                            September 30,                           September 30,
                          2011          2010       Change         2011          2010       Change
  Product Sales        $   30,433     $ 22,840          33 %    $  79,484     $ 61,496          29 %
  Promotion Services        6,992           -                      12,711           -

  Total Revenues       $   37,425     $ 22,840          64 %    $  92,195     $ 61,496          50 %

Product sales were $30.4 million and $79.5 million for the three- and nine-month periods ended September 30, 2011, respectively, compared to $22.8 million and $61.5 million for the corresponding periods in 2010. The increase of $7.6 million, or 33%, for the three-month period ended September 30, 2011 and $18.0 million, or 29%, for the nine-month period ended September 30, 2011 compared to the same periods in the prior year, were primarily attributable to increased sales of ZADAXIN and due to the addition of NovaMed product sales as a result of the acquisition of NovaMed. ZADAXIN sales were $27.9 million and $75.1 million for the three- and nine- month periods ended September 30, 2011, compared to $22.8 million and $61.5 million for the corresponding periods of 2010. Our overall ZADAXIN revenue growth was attributable to an increase in the quantity of ZADAXIN sold primarily due to further market penetration in China.

Promotion services revenue of $7.0 million and $12.7 million for the three- and nine- month periods ended September 30, 2011, respectively, reflect the addition of NovaMed promotion services as a result of the acquisition of NovaMed and was related to the distribution of products under promotional contracts.

Total revenues to China were $36.4 million and $89.7 million, or 97% of sales for the three- and nine-month periods ended September 30, 2011, compared to $22.1 million and $59.4 million, or 97% of sales for the corresponding periods in 2010.

For the three-month period ended September 30, 2011, sales to two importing or distributor agents in China accounted for approximately 69% and 18% of our product sales. For the three-month period ended September 30, 2010, sales to two importing or distributor agents in China accounted for approximately 64% and 33% of our product sales. For the nine-month period ended September 30, 2011, sales to three importing or distributor agents in China accounted for approximately 59%, 19% and 13% of our product sales. For the nine-month period ended September 30, 2010, sales to two importing or distributor agents in China accounted for approximately 66% and 20% of our product sales. Last year, Sinopharm Group Co. Limited acquired a majority interest in our two largest importers, Shanghai Lingyun Pharmaceutical Company Ltd. and Guangdong South Pharmaceutical Foreign Trade Company Ltd. We do not believe these acquisitions will impact our sales. Our experience with our largest importers or distributors has been good and we anticipate that we will continue to sell a majority of our product to them.


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The following tables summarize the period over period changes in our cost of product sales (in thousands):

Three Months Ended Nine Months Ended September 30, September 30, 2011 2010 Change 2011 2010 Change Cost of Product Sales $ 5,024 $ 3,146 60 % $ 13,301 $ 9,445 41 %

Cost of product sales were $5.0 million and $13.3 million for the three- and nine-month periods ended September 30, 2011, respectively, compared to $3.1 million and $9.4 million for the same periods in the prior year. The increases of $1.9 million, or 60%, and $3.9 million, or 41%, for the three- and nine-month periods ended September 30, 2011 compared to the same periods in the prior year were attributable to higher ZADAXIN sales and the addition of NovaMed cost of product sales as a result of the acquisition of NovaMed. ZADAXIN cost of sales were $3.8 million and $10.8 million for the three- and nine- month periods ended September 30, 2011, respectively, compared to $3.1 million and $9.4 million for the corresponding periods in 2010. Gross margin for ZADAXIN was 86.3% and 86.2% for the three months ended September 30, 2011 and 2010, respectively, and was 85.7% and 84.6% for the nine months ended September 30, 2011 and 2010, respectively. The increase in gross margin for ZADAXIN for the three- and nine- month period ended September 30, 2011, compared to the three- and nine- month period ended September 30, 2010, was due primarily to lower per vial production costs mainly as a result of increased production.

We expect total revenues and cost of product sales to increase in 2011 compared to 2010 due to increased unit sales of ZADAXIN related to further market penetration in China, and as a result of the addition of revenues from NovaMed's product portfolio. Through September 30, 2011, we have been able to maintain our ZADAXIN gross margin in part due to relatively stable or even decreasing costs of sales, and in part due to maintaining a relatively stable sales price. ZADAXIN's list price in China is currently under review by regulatory authorities. We anticipate that a price reduction may occur, and if a substantial reduction in the list price occurred, our revenues and our gross margins for ZADAXIN would be substantially reduced.

We expect our ZADAXIN cost of product sales and gross margins to fluctuate from period to period depending upon the level of sales and price of our products, the absorption of product-related fixed costs, currency exchange fluctuations, any charges associated with excess or expiring finished product inventory and the timing of other inventory period costs.

Sales and Marketing:

The following table summarizes the period over period changes in our sales and marketing expenses (in thousands):

Three Months Ended Nine Months Ended September 30, September 30, 2011 2010 Change 2011 2010 Change Sales and Marketing $ 15,222 $ 5,445 180 % $ 33,311 $ 15,996 108 %

Sales and marketing expenses for the three months ended September 30, 2011 increased by $9.8 million, or 180%, compared to the same period in 2010, and sales and marketing expenses for the nine months ended September 30, 2011 increased by $17.3 million, or 108%, compared to the same period in 2010. Increases of $8.2 million and $14.2 million, for the three- and nine- month periods ended September 30, 2011, respectively, were attributable to NovaMed operations as a result of the acquisition of NovaMed and its sales force of over 450 individuals. The remaining increases of $1.6 million and $3.1 million, for the three- and nine- month periods ended September 30, 2011, related to increased growth in the ZADAXIN sales force in China of approximately 34 additional sales individuals, and further market penetration in China resulting in increased sales and marketing costs for compensation and benefits, sales incentives, travel, medical training, and business taxes. We expect sales and marketing expenses to be higher in 2011 compared to 2010 due to increased sales efforts of ZADAXIN, primarily in China, and the addition of NovaMed sales and marketing expenses as a result of our acquisition of NovaMed in April 2011.


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Amortization of Acquired Intangible Assets:

For the three- and nine- months ended September 30, 2011, we recognized $0.9 million and $1.6 million in amortization of acquired intangible assets expense, reflecting the amortization of promotion and distribution contract intangible assets acquired as part of the NovaMed acquisition. There was no similar expense for the corresponding periods of 2010. We expect $3.4 million per year of annual amortization expenses in future years.

Research and Development ("R&D"):

The following table summarizes the period over period changes in our R&D expenses (in thousands):

. . .

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