SciClone Pharmaceuticals, Inc.
SCICLONE PHARMACEUTICALS INC (Form: 10-Q, Received: 08/09/2017 16:20:22)

Table of Contents

 





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

_____________________________________________



FORM 10-Q

__________________________________ _______

  (Mark One)



 

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



For the quarterly period ended June 30 , 2017



OR





 

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



For the transition peri od from ____________to _____________







Commission file number:  0-19825

_____________________________________________



SCICLONE PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

_____________________________________________



Delaware

94-3116852

(State or other jurisdiction of

(I.R.S. employer

incorporation or organization)

Identification no.)



 

950 Tower Lane, Suite 900, Foster City, California

94404

(Address of principal executive offices)

(Zip code)



(650) 358-3456

(Registrant’s telephone number, including area code)



Not Applicable

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

_____________________________________________



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.        Yes           No      

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes           No      

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer , a non-accelerated filer, a smaller reporting company , or an emerging growth company. See definition of "large accelerated filer," "accelerated filer," "smaller reporting company , "   and “emerging growth company” in Rule 12b-2 of the Exchange Act.



 

 

 

 

 

 

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

  

Smaller Reporting Company

 



 

 

 

Emerging Growth Company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      Yes           No      

As of August 3 ,   2017 ,   52, 191,854 shares of the registrant’s Common Stock, $0.001 par value, were issued and outstanding.





 

 


 

Table of Contents

 

SCICLONE PHARMACEUTICALS , INC.

TABLE OF CONTENTS



 

 

 

 

 

 

 

 

 

  

PAGE   NO.

 

PART I.

 

FINANCIAL INFORMATION

  

 

 

 



 

 

Item 1.

 

Financial Statements (Unaudited)

  

 

 

 



 

 



 

Condensed Consolidated Balance Sheets as of June 30 , 2017 and December 31, 201 6  

  

 

  



 

 



 

Condens ed Consolidated Statements of Income for the t hree and six month s ended June 30 , 2017 and  201 6  

  

 

  



 

 



 

Condensed Consolidated Statements of Comprehensive Income for the three and six   months ended June 30 , 201 7 and 201 6

  

 

  



 

 



 

Condensed Consolidated Statements of Cash Flows for the six month s ended June 30 , 201 7 and 201 6  

  

 

  



 

 



 

Notes to Unaudited Condensed Consolidated Financial Statements

  

 

  



 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

 

19 

  



 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  

 

30 

  



 

 

Item 4.

 

Controls and Procedures

  

 

30 

  



 

 

PART II.

 

OTHER INFORMATION

  

 

 

 



 

 

Item 1.

 

Legal Proceedings

  

 

31 

  



 

 

Item 1A.

 

Risk Factors

  

 

31 

  



 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

  

 

47 

  



 

 

Item 3.

 

Defaults Upon Senior Securities

  

 

47 

  



 

 

Item 4.

 

Mine Safety Disclosures

  

 

47 

  



 

 

Item 5.

 

Other Information

  

 

47 

  



 

 

Item 6.

 

Exhibits

  

 

47 

  



 

 

 Signature

 

 

  

 

48 

  



 

 

 

 

 

 







 

2


 

Table of Contents

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)



SCICLONE PHARMACEUTICALS , INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)







 

 

 

 

 

 

 

 

June 30,

 

December 31,

 

 

2017

 

2016

ASSETS

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

157,328 

 

$

134,395 

Accounts receivable, net of allowances of $0 and $0 as of June 30, 2017 and December 31, 2016, respectively

 

 

48,002 

 

 

41,510 

Inventories

 

 

22,039 

 

 

16,587 

Prepaid expenses and other current assets

 

 

3,639 

 

 

3,241 

Total current assets

 

 

231,008 

 

 

195,733 

Property and equipment, net

 

 

2,002 

 

 

2,002 

Investment in third party (Note 4)

 

 

724 

 

 

794 

Goodwill

 

 

31,592 

 

 

30,838 

Other assets

 

 

12,285 

 

 

12,531 

Total assets

 

$

277,611 

 

$

241,898 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

7,066 

 

$

3,645 

Accrued and other current liabilities

 

 

20,561 

 

 

22,796 

Total current liabilities

 

 

27,627 

 

 

26,441 

Other long-term liabilities

 

 

117 

 

 

92 

Commitments and Contingencies (Note 10)

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

Preferred stock; $0.001 par value; 10,000,000 shares authorized; no shares issued and outstanding

 

 

 —

 

 

 —

Common stock; $0.001 par value; 100,000,000 shares authorized; 52,191,854 and 51,236,952 shares issued and outstanding as of June 30, 2017 and December 31, 2016, respectively

 

 

52 

 

 

51 

Additional paid-in capital

 

 

311,837 

 

 

304,599 

Accumulated other comprehensive loss

 

 

(902)

 

 

(1,520)

Accumulated deficit

 

 

(61,120)

 

 

(87,765)

Total stockholders’ equity

 

 

249,867 

 

 

215,365 

Total liabilities and stockholders’ equity

 

$

277,611 

 

$

241,898 



 

 

 

 

 

 



See accompanying notes to unaudited condensed consolidated financial statements.

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Table of Contents

 



SCICLONE PHARMACEUTICALS , INC.

CONDE NSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



 

2017

 

2016

 

2017

 

2016

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Product sales, net

 

$

43,369 

 

$

37,869 

 

$

85,006 

 

$

73,189 

Promotion services

 

 

1,151 

 

 

1,122 

 

 

2,406 

 

 

2,301 

Total net revenues

 

 

44,520 

 

 

38,991 

 

 

87,412 

 

 

75,490 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product sales

 

 

5,654 

 

 

5,712 

 

 

11,819 

 

 

11,525 

Sales and marketing

 

 

15,435 

 

 

14,432 

 

 

28,200 

 

 

26,784 

Research and development

 

 

2,828 

 

 

4,765 

 

 

5,323 

 

 

6,232 

General and administrative

 

 

8,286 

 

 

8,129 

 

 

15,516 

 

 

15,572 

Total operating expenses

 

 

32,203 

 

 

33,038 

 

 

60,858 

 

 

60,113 

Income from operations

 

 

12,317 

 

 

5,953 

 

 

26,554 

 

 

15,377 

Non-operating income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

 

297 

 

 

263 

 

 

593 

 

 

522 

Other income (expense), net

 

 

167 

 

 

(249)

 

 

1,242 

 

 

(121)

Income before provision (benefit) for income tax

 

 

12,781 

 

 

5,967 

 

 

28,389 

 

 

15,778 

Provision (benefit ) for income tax

 

 

589 

 

 

(371)

 

 

1,601 

 

 

1,576 

Net income

 

$

12,192 

 

$

6,338 

 

$

26,788 

 

$

14,202 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

$

0.24 

 

$

0.13 

 

$

0.52 

 

$

0.29 

Diluted net income per share

 

$

0.23 

 

$

0.12 

 

$

0.50 

 

$

0.27 



 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares used in computing net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic shares outstanding

 

 

51,820 

 

 

49,897 

 

 

51,630 

 

 

49,743 

Diluted shares outstanding

 

 

53,252 

 

 

52,819 

 

 

53,155 

 

 

52,405 



See accompanying notes to unaudited condensed consolidated financial statements.

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Table of Contents

 

SCICLONE PHARMACEUTICALS , INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



 

2017

 

2016

 

2017

 

2016

Net income

 

$

12,192 

 

$

6,338 

 

$

26,788 

 

$

14,202 

Other comprehensive income (loss), net of income tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

 

466 

 

 

(787)

 

 

688 

 

 

(590)

Unrealized loss on available-for-sale investment in common stock of third party

 

 

(229)

 

 

 —

 

 

(70)

 

 

 —

Total other comprehensive income

 

 

237 

 

 

(787)

 

 

618 

 

 

(590)

Total comprehensive income

 

$

12,429 

 

$

5,551 

 

$

27,406 

 

$

13,612 



 

 

 

 

 

 

 

 

 

 

 

 



See accompanying notes to unaudited condensed consolidated financial statements.

5


 

Table of Contents

 

SCICLONE PHARMACEUTICALS , INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)  





 

 

 

 

 

 



 

Six Months Ended



 

June 30,

 

 

2017

 

2016

Operating activities:

 

 

 

 

 

 

Net income

 

$

26,788 

 

$

14,202 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Non-cash expense related to stock-based compensation

 

 

3,853 

 

 

2,469 

Provision for expiring inventory

 

 

 —

 

 

34 

Depreciation and amortization

 

 

514 

 

 

493 

Loss on disposal of fixed assets

 

 

 

 

Deferred income taxes

 

 

 —

 

 

127 

Unrealized foreign exchange gain

 

 

(289)

 

 

 —

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable, net

 

 

(6,170)

 

 

3,911 

Inventories

 

 

(126)

 

 

527 

Prepaid expenses and other assets

 

 

(809)

 

 

348 

Accounts payable

 

 

(931)

 

 

(2,529)

Accrued and other current liabilities

 

 

(2,522)

 

 

(346)

Deferred revenue

 

 

 —

 

 

(140)

Other long-term liabilities

 

 

24 

 

 

28 

Net cash provided by operating activities

 

 

20,339 

 

 

19,125 

Investing activities:

 

 

 

 

 

 

Purchases of property and equipment

 

 

(674)

 

 

(54)

Net cash used in investing activities

 

 

(674)

 

 

(54)

Financing activities:

 

 

 

 

 

 

(Payments of cost) proceeds from issuances of common stock, net

 

 

3,183 

 

 

(2,888)

Net cash provided by (used in) financing activities

 

 

3,183 

 

 

(2,888)

Effect of exchange rate changes on cash and cash equivalents

 

 

85 

 

 

23 

Net increase in cash and cash equivalents

 

 

22,933 

 

 

16,206 

Cash and cash equivalents, beginning of period 

 

 

134,395 

 

 

101,403 

Cash and cash equivalents, end of period

 

$

157,328 

 

$

117,609 



 

 

 

 

 

 

Supplemental disclosure of non-cash operating activities:

 

 

 

 

 

 

Release of restricted cash in escrow for SEC settlement

 

$

 —

 

$

12,826 



See accompanying notes to unaudited condensed consolidated financial statements.



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Table of Contents

 

SCICLONE PHARMACEUTICALS , INC.

Notes to Unaudited Condensed Con solidated Financial Statements

Note 1 —   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of SciClone Pharmaceuticals, Inc. (“SciClone” or the “Company”) have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) consistent with those applied in, and should be read in conjunction with, the audited consolidated financial statements and the notes thereto for the year ended December 31, 2016 included in the Company’s Form 10-K as filed with the Securities and Exchange Commission (“SEC”). The Company prepared the unaudited condensed consolidated financial statements following the requirements of the SEC for interim reporting. As permitted under those rules, certain footnotes or other information that are normally required by GAAP can be condensed or omitted.

The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

The interim financial information reflects all adjustments, consisting only of normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented and are not necessarily indicative of results for subsequent interim periods or for the full year. The unaudited condensed consolidated balance sh eet data as of December 31, 2016 is derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make informe d estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ material ly from those estimates.

Customer Concentration

In China, pharmaceutical products are imported and distributed through a tiered method of distribution. For the Company’s proprietary product ZADAXIN, the Company manufactures its product using its U.S. and European contract manufacturers, and it generates its product sales revenue through sales of ZADAXIN products to Sinopharm Holding Lingyun Biopharmaceutical (Shanghai) Co. Limited (“Sinopharm”). Sinopharm acts as an importer, and also as the top “tier” of the distribution system (“Tier 1”) in China. The Company’s ZADAXIN sales occur when the importer purchases product from the Company, without any right of return except for replacement of product in the events of damaged product or quality control issues. As the Company bears risk of loss until delivery has occurred, revenue is not recognized until the shipment reaches its destination. After the Company’s sale of ZADAXIN to the importer, Sinopharm clears products through China import customs, sells directly to large hospitals and holds additional product it has purchased in inventory for sale to the next tier in the distribution system. The second-tier (“Tier 2”) distributors are responsible for the further sale and distribution of the products they purchase from the importer, either through sales of product directly to the retail level (hospitals and pharmacies), or to third-tier (“Tier 3”) local or regional distributors who, in turn, sell products to hospitals and pharmacies. The Company’s other product sales revenues result from the sale of the Company’s in-licensed products to importing agents and distributors.

Promotion services revenues result from fees received for exclusively promoting products for certain pharmaceutical partners. These importing agents, distributors and partners are the Company’s customers.

Sinopharm cont ributed 93 % of the Company’s total net revenue for both the three month periods ended June 30 , 2017 and 2016 , respectively, which revenues related to the Company’s China segment. Sinopharm contributed 92% of the Company’s tota l net revenue for both the six month periods ended June 30, 2017 and 2016, respectively, which revenues related to the Company’s China segment.   There were no other customers that exceeded 10% of the Company’s total net revenue in the periods presented.

7


 

Product sales o f   $ 4 1.6   million or 93 % and $ 3 6.5   million or 9 4 % , for the t hree months ended June 30 , 2017 and 2016 , respectively, related to consolidated sales of ZADAXIN. Of the $41.6 million in ZADAXIN revenues in the second quarter of 2017 ,   $ 3.3 million was attributed to revenues fr om sales generated in the first quarter of 2017   but   r ecognized   in the second quarter of 2017   for first quarter sales that were above the reference (baseline) tender price under a provision in the agreement with the Company’s China distributor to share, in part, in the burden of price reductions   and the benefit of higher pricing in provinces with higher tender prices . In the second quarter of 2017, revenue was reduced by $0.8 million for sales in the second quarter that we estimate will be sold at prices below the reference tender price under a provision in the agreement with the Company’s China distributor .   Product sales of $ 81.1 million or 92% and $70.1 million or 93 % , for the six months ended June 30, 2017 and 2016, respectively, related to consolidate d sales of ZADAXIN. Of the $81.1  m illion in ZADAXIN revenues for the first half of 2017 ,   $4.2 million was attributed to revenues from sales generated in the fourth quarter of 2016 and $3.3 million was attributed to revenues from sales generated in the first quarter that were both above the reference (baseline) tender price under a provision in the agreement with the Company’s China distributor to share, in part, in the burden of price reductions   and the benefit of higher pricing in provinces with higher tender prices and which had no corresponding revenues in the same 2016 period . In the six months ended June 30, 2017, revenue was also reduced by $0.8 million for sales in the second quarter that we estimate will be sold at prices below the reference tender price under a provision in the agreement with the Company’s China distributor.   As of June 30 , 2017 , approximately $ 44.7 million, or 93 % , of the Company's accounts receivable was attributable to one customer, Sinopharm, in China. The Company generally does not require collateral from its customers. The Company maintains reserves for potential credit losses and such actual losses may vary significantly from its estimates.

Per the Company’s previous contractual arrangement with Sinopharm through December 31, 2015, and a renewed contractual arrangement with Sinopharm (the Company’s sole distributor for ZADAXIN in China) which took effect January 1, 2016, the Company’s sales of ZADAXIN to Sinopharm w e re denominated in U . S .   dollars through June 30, 2016 . However, the e stablished importer price was adjusted quarterly based upon exchange rate fluctuations between the U . S . dollar and Chinese Yuan Renminbi (“RMB”) .   Effective July 1, 2016, the Company’s sales of ZADAXIN to Sinopharm were and have continue d to be denominated in RMB. A significant portion of the Company’s other revenues and expenses are also denominated in RMB and a significant portion of the Company’s assets and liabilities are denominated in RMB and all are exposed to foreign exchange risk. In the recent year , the RMB has experienced d evaluation. Such devaluation negatively affect s the U . S . dollar value of revenues while it positively affects the U.S. dollar value of China operating expenses .   RMB is not freely convertible into foreign currencies. In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions at the exchange rates quoted by the People’s Bank of China. Remittances in currencies other than RMB by the Company in China require certain supporting documentation in order to process the remittance.

Accounts Receivable  

Receivable Reserve.   The Company records a receivable reserve based on a specific review of its overdue invoices. The Company’s estimate for a reserve is determined after considering its existing contractual payment terms, payment patterns of its customers and individual customer circumstances, the age of any outstanding receivables and its current customer relationships. Accounts receivable are written off at the point when they are considered uncollectible.

As of June 30 , 2017 and December 31, 2016 , the Company determined no bad debt reserve was necessary.

Revenue Recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, services have been rendered or delivery has occurred, the price to the buyer is fixed or determinable and collectability is reasonably assured.

Product Revenue. The Company recognizes product revenue from selling manufactured ZADAXIN product at the time of delivery. Sales of ZADAXIN to Sinopharm are recognized upon arrival of a shipment to its destination, which marks the point when title and risk of loss to product are transferred. The Company also earns product revenue from purchasing medical products from pharmaceutical companies and selling them directly to importers or distributors. The Company recognizes revenue related to these products based on the “sell-in” method, when the medical products have been delivered to the importers or distributors. Payments by the importing agents and distributors are not contingent upon sale to the end user by the importing agents or distributors.

8


 

Effective January 1, 2016, the Company’s new contractual arrangement with its China importer and distributor for ZADAXIN, Sinopharm, is resulting in the later recognition (relative to practices prevailing under the old contractual arrangement through December 31, 2015) of a portion of the Company’s revenue due from Sinopharm related to situations where the provincial tender price is greater relative to a reference (baseline) tender price. The tender price is the ultimate retail end price approved by provincial authorities. There is a price adjustment mechanism in the new contractual arrangement whereby Sinopharm is invoiced at a lower base price relative to that prevailing in the previous agreement. The lower base price (reduced by estimated price compensation payable to Sinopharm for situations where the provincial tender price is lower than the reference (baseline) tender price) is recorded as revenue at the time the sale is completed upon ar rival at destination. Recently, Guangdong and Fujian provinces have each announced maximum prices for ZADAXIN that are approximately six and four percent lower, respectively, than the reference (baseline) tender price. We expect these provincial decisions to affect the pricing of ZADAXIN in these provinces with respect to sales made pursuant to contracts dated on and after March 2017 for Guangdong and Fujian, and to affect pricing in other provinces, but the exact timing and consequences to our pricing, especially in other provinces, is uncertain. Sinopharm is invoiced for the portion of the price that results from situations where the provincial tender price is greater than the reference (baseline) tender price at a later time, and that portion of the price is recognized as revenue after the amount has been agreed to with them. It is expected that the price increment due to the Company related to sales in a quarter under the price adjustment mechanism for provinces with tender prices above the reference (baseline) tender price will continue to be recognized on a rolling one-to-two quarter delayed basis relative to the originating sales quarter. 

Promotion Services Revenue.   The Company recognizes promotion services revenue after designated medical products are delivered to the distributors as specified in a promotion services contract, which marks the period when marketing and promotion services have been rendered and the revenue recognition criteria are met.

Revenue Reserve.   The Company generally maintains a revenue reserve for product returns based on estimates of the amount of product to be returned by its customers that are 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. Importing agents or distributors do not have contractual rights of return except under limited terms regarding product quality. However, the Company is expected to replace products that have expired or are deemed to be damaged or defective when delivered upon arrival at destination. The calculation of the revenue reserve requires estimates and involves a high degree of subjectivity and judgment. As a result of the uncertainties involved in estimating the revenue reserve, there is a possibility that materially different amounts could be reported under different conditions or using different assumptions.

As of June 30 , 2017 and December 31, 2016, the Company’s revenue reserves were $ 0.3 million and $0.3 million , respectively .  

The Company evaluates the need for a returns reserve quarterly and adjusts it when events indicate that a change in estimate is appropriate. Changes in estimates could materially affect the Company’s results of operations or financial position. It is possible that the Company may need to adjust its estimates in future periods.

Inventories

Inventories consist of raw materials, work in progress and finished products. Inventories are valued at the lower of cost or net realizable value , with cost determined on a first-in, first-out basis, and include amounts related to materials, labor and overhead. The Company periodically reviews the inventory in order to iden tify excess and obsolete items . If obsolete or excess items are observed and there are no alternate uses for the inventory, the Company will record a write-down to net realizable value in the period that the impairment was first indicated. For the three mo nth periods ended June 30 , 2017 and 2016 , the Company did not record any write-downs related to inventory.  

Loans Receivable

Loans receivable are due from a single third party (see Note 5 ). Loans are initially recorded, and continue to be carried, at unpaid principal balances under “other assets” on the unaudited condensed consolidated balance sheet s . Carried balances are subsequently adjusted for payments of principal or adjustments to the allowance for loan losses to account for any impairment. Interest income is recognized over the term of the loans and is calculated using the simple-interest method, as the loans do not have associated premium or discount. If the loans were to experience impairment, interest income would not be recognized unless the likelihood of further loss was remote.

Although the measurement basis is unpaid principal (as adjusted for subsequent payments or impairment), not fair value, the loans receivable would qualify as Level 3 measurements under the fair value hierarchy (Note 2) due to the presence of significant unobservable inputs related to the counterparty, which is a private entity.

9


 

Management considers impairment to exist when, based on current information or factors (such as payment history, value of collateral, and assessment of the counterparty’s current creditworthiness), it is probable that principal and interest payments will not be collected according to the contractual agreements. Management considers a loan payment delinquent when not received by th e due date. As of June 30 , 2017 and December 31, 2016 , management concluded the loans receivable were not impaired, and there was no allowance for loan losses.

Net Income Per Share

Basic net income per share has been computed by dividing net income by the weighted-average number of shares of common stock outstanding for the period. Diluted net income per share is computed by dividing net income by the weighted-average number of common equivalent shares outstanding for the period. Diluted net income per share includes any dilutive impact from outstanding stock options, stock awards and the employee stock purchase plan using the treasury stock method.

The following is a reconciliation of the numerator and denominators of the basic and diluted net income per share computations (in thousands, except per share amounts):  





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



 

2017

 

2016

 

2017

 

2016

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

12,192 

 

$

6,338 

 

$

26,788 

 

$

14,202 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding used to compute basic net income per share

 

 

51,820 

 

 

49,897 

 

 

51,630 

 

 

49,743 

Effect of dilutive securities

 

 

1,432 

 

 

2,922 

 

 

1,525 

 

 

2,662 

Weighted-average shares outstanding used to compute diluted net income per share

 

 

53,252 

 

 

52,819 

 

 

53,155 

 

 

52,405 

Basic net income per share

 

$

0.24 

 

$

0.13 

 

$

0.52 

 

$

0.29 

Diluted net income per share

 

$

0.23 

 

$

0.12 

 

$

0.50 

 

$

0.27 



For the t hree months ended June 30 , 2017 and 2016 , outstanding stock options and awards for 3,411,268 and 1 20,2 70 shares, respectively, were excluded from the calculation of diluted net income per share because the effect from the assumed exercise or issuance of these options and awards calculated under the treasury stock method would have been anti-dilutive. In addition, for the three months ended June 30 , 201 7 and 201 6 , outstanding stock options and awards for 375,000 and 312,500 shares, respective ly, subject to performance conditions were excluded from the calculation of diluted net income per share because the performance criteria had not been met and were not considered probable of being met.

For the six months ended June 30 , 2017 and 2016, outstanding stock options and awards for 3,023,879 and 1,974,551 shares, respectively, were excluded from the calculation of diluted net income per share because the effect from the assumed exercise or issuance of these options and awards calculated under the treasury stock method would have been anti-dilutive. In addition, for the six months ended June 30 , 2017 and 2016, outstandi ng stock options and awards for 375,000 and 312,500 shares, respective ly, subject to performance conditions were excluded from the calculation of diluted net income per share because the performance criteria had not been met and were not considered probable of being met.

Error Corrections

The Company provided $1.2 million of additional income tax expense, and recorded a corresponding accrual in accrued and other current liabilities , during the three months ended March 31, 2016 to correct an error. The error correction reflected the recognition of a previously unrecognized liability for an uncertain tax position related to the potential non - deductibility, under PRC tax regulations, of certain marketing costs related to the Company’s China operations. The adjustment related to tax years 2013 to 2015 and reflected the estimated tax exposure for each year as well as accrued interest thereon; such tax and interest amounts were $0. 3 million, $0.5 million, and $0.4 million for the full years 2013, 2014, and 2015, respectively. The Company’s management evaluated the effects of the error on each prior annual and interim period, as well as the total error accumulated at the end of each respective prior period, and concluded under both approaches that the effects of the error were not material to previously issued annual or interim financial statements. The Company’s management also evaluated the total amount of the error correction in relation to actual results for full year 2016 and c oncluded the impact wa s not material to the 2016 financial statements . T he total adjustment was recorded out-of-period in the first quarter of 2016.

10


 

New Accounting Standards Updates

Standards Recently Effective

In November 2015, the FASB issued ASU 2015-17, " Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes ”. This ASU amends existing guidance to require that deferred income tax liabilities and assets be classified as noncurrent in a classified balance sheet, and eliminates the prior guidance which required an entity to separate deferred tax liabilities and assets into a current amount and a noncurrent amount in a classified balance sheet. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods. The new guidance may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company adopted the new guidance with effect f rom January 1, 2017 and is apply ing the new guidance retrospectively. The impact of adopting this guidance is not material to the consolidated financial statements given the Company’s limited deferred tax amounts.

In March 2016, the FASB issued ASU 2016-09, “ Comp ensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ,” which outlines new provisions intended to simplify various aspects related to accounting for share-based payments and their presentation in the financial statements. The Company adopted this ASU as stipulated with effect from January 1, 2017.  Of the various provisions included in the ASU, the only provision that at present is m aterial   to the Company’s financial statements is the provision providing alternatives to account for forfeitures of share-base d awards using either estimated forfeitures ( periodically adjusted for differences from actuals) or simply using actual forfeitures.  The Company has   changed   its accounting policy upon the adoption of this updated standard to account for forfeitures on an actual basis.  This change resulted in a cumulative-effect adjustment related to prior periods (Note 9) which was not material and is not expected to be material to the consolidated financial statements in future periods given the Company’s past and present experience with its grants of share-based awards and related pre-vesting forfeitures.

Standards Effective in Future Periods

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, "Revenue from Contracts with Customers (Topic 606)" , which contains new accounting literature relating to how and when a company recognizes revenue. Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. ASU 2014-09 is effective for the Company’s fiscal year beginning January 1, 2018, which reflects a one year deferral approved by the FASB in July 2015, and will be adopted by the Company from January 1, 2018. The Company is currently undertaking an evaluation of its revenue contracts to determine what impact, if any, the adoption of ASU 2014-09 will have on its financial statements and related disclosures. The Company anticipates the impact of ASU 2014-09 will likely be limited to the timing of recognition of its variable consideration. This variable consideration arises from situations where the Company’s exclusive distributor in China is invoiced at a later time subsequent to the original sale for the portion of the price that results from situations where the provincial tender price is greater than the reference (baseline) tender price. Such amount is currently recognized as revenue after the amount has been agreed to with the distributor in a later quarter relative to the originating sales quarter. The timing of the recognition of such amounts is expected to be earlier (estimated at the time of the originating product sale) under the new guidance.  The Company plans to finalize its assessment in the thir d quarter of 2017. The standard permits the use of either the full retrospective or modified retrospective transition method. The Company has d etermined it will employ the full retrospective transition method .

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Liabilities” . The amended guidance (i) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (ii) eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is currently required to be disclosed for financial instruments measured at fair value; (iii) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments and (iv) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, or calendar 2018 for the Company. The amended guidance should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company has evaluated the impact of adoption of this guidance on its consolidated financial statements and has concluded that the impact will be limited to a cumulative-effect adjustment for its investment in the common stock of a third-party which is currently classified as an available-for-sale equity investment, as well as prospective recognition of changes in the fair value of such investment, to the extent the Company continues to own the investment, as a component of net income.

11


 

In February 2016, the FASB issued ASU 2016-02, “ Leases (Topic 842) ”. Under the new guidance, lessees will be required to recognize a lease liability and a lease asset for all leases, including operating leases, with a term greater than 12 months on the balance sheet. The update also expands the required quantitative and qualitative disclosures surrounding leases. This update is effective for the Company from calendar 2019 and from the first interim period of calendar 2019, with earlier application permitted. The Company is evaluating the impact of the adoption of this update on its consolidated financial statements and related disclosures.

In June 2016, the FASB issued ASU 2016-13, “ Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ” This ASU requires a financial asset (or group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The standard is effective for the Company from calendar 2020, with early adoption permitted for calendar 2019. The Company has yet to commence an evaluation of the impact of the adoption of this standard on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15,   “Classification of Certain Cash Receipts and Cash Payments (Topic 230)."   Current GAAP is unclear or does not include specific guidance on how to classify certain transactions in the statement of cash flows. This ASU is intended to reduce diversity in practice in how eight particular transactions are classified in the statement of cash flows. ASU No. 2016-15 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, provided that all of the amendments are adopted in the same period. Entities will be required to apply the guidance retrospectively. If it is impracticable to apply the guidance retrospectively for an issue, the amendments related to that issue would be applied prospec tively. ASU 2016-15 is not expected to have a material impact on the Company's consolidated financial statements .

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment" (Topic 350), which removes the requirement to perform a “Step 2” hypothetical purchase price allocation to measure goodwill impairment if “Step 1” of the traditional two-step goodwill impairment model is failed. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value (the determination from “Step 1”), not to exceed the carrying amount of goodwill. ASU 2017-04 is effective for the Company for annual and interim periods beginning January 1, 2020, with early adoption permitted, and is to be applied prospectively. ASU 2017-04 will impact the Company’s goodwill balance to the extent such goodwill balance exists at the adoption date and to the extent that the fair value of the Company’s China reporting unit is less than its carrying value .



Note 2 —   Fair Value Measurements

Fair value is defined 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 must maximize the use of observable inputs and minimize the use of unobservable inputs. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. 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 following table s   represent the Company’s fair value hierarchy for its financial assets (cash equivalents   and common stock investment ) measured at fair value on a recurring basis ( in thousands ):





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

Fair Value Measurements as of June 30, 2017 Using



 

Quoted Prices in

 

Significant

 

 

 

 

 

 



 

Active Markets

 

Other

 

Significant

 

 

 



 

for

 

Observable

 

Unobservable

 

Balance



 

Identical Assets

 

Inputs

 

Inputs

 

as of

Description

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

June 30, 2017

Money market funds

 

$

19,739 

 

$

 —

 

$

 —

 

$

19,739 

Common stock investment in third party (Note 4)

 

$

 —

 

$

724 

 

$

 —

 

$

724 

Total

 

$

19,739 

 

$

724 

 

$

 —

 

$

20,463 



 

 

 

 

 

 

 

 

 

 

 

 

12


 







 

 

 

 

 

 

 

 

 

 

 

 



 

Fair Value Measurements as of December 31, 2016 Using



 

Quoted Prices in

 

Significant

 

 

 

 

 

 



 

Active Markets

 

Other

 

Significant

 

 

 



 

for

 

Observable

 

Unobservable

 

Balance



 

Identical Assets

 

Inputs

 

Inputs

 

as of

Description

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

December 31, 2016

Money market funds

 

$

19,701 

 

$

 —

 

$

 —

 

$

19,701 

Common stock investment in third party (Note 4)

 

$

 —

 

$

794 

 

$

 —

 

$

794 

Total

 

$

19,701 

 

$

794 

 

$

 —

 

$

20,495 



 

 

 

 

 

 

 

 

 

 

 

 

 



Note 3 —   Inventories

Inventories   consisted of the following (in thousands) :



 

 

 

 

 

 



 

 

 

 

 

 



 

June 30,

 

December 31,



 

2017

 

2016

Raw materials

 

$

7,116 

 

$

5,304 

Work in progress

 

 

444 

 

 

498 

Finished goods

 

 

14,479 

 

 

10,785 



 

$

22,039 

 

$

16,587 



A s of June 30 , 2017 and December 31, 2016, the Company had $ 4.0 million and  $ 3.3 million , respectively,   in inventory held at distributors related t o   non-ZADAXIN products .   Raw materials increased $1.8 million from the purchase of   an active pharmaceutical ingredient (API) for increased p roduction of safety stocks in anticipation of the   renewal of the Import Drug License (“IDL”) for   Z ADAXIN   in the fourth quarter of 2017. Work in progress decreased by $53,000 due to timing of production. Finished goods increas ed by $3.7 million, primari ly due to forecasted increase s in Z ADAXIN sales volumes for the third quarter as well as buildup of safety stock of finished Z ADAXIN   product in anticipat ion of the ZADAXIN IDL renewal.

Note 4 —   Investment in Third Party

On September 9, 2016, the Company and Soligenix, Inc., a publicly-traded entity, entered into an exclusive license agreement (the “License Agreement”), including a common stock purchase agreement, pursuant to which Soligenix granted rights to the Company to develop, promote, market, distribute and sell an oral mucositis-targeted drug candidate (“SGX942”) in the People’s Republic of China, Hong Kong, Macau, Taiwan, South Korea , and Vietnam (the “Territory”). Under the terms of the License Agreement, the Company will be responsible for all aspects of development, product registration, and commercialization in the Territory, having access to data generated by Soligenix. In exchange for exclusive rights, beyond an upfront payment, the Company will pay to Soligenix royalties on net sales, and Soligenix will supply commercial drug product to the Company on a cost-plus basis, while maintaining worldwide manufacturing rights. This exclusive agreement builds on an existing collaboration between the two companies established in 2013, in which the Company provided its complete oral mucositis clinical and regulatory data library to Soligenix in exchange for certain, previously undisclosed, commercialization rights to the oral mucositis drug candidate in the Greater China market. As the Company obtained rights for Greater China (mainland China, Hong Kong, and Macau) in the earlier 2013 exchange, the September 2016 agreement in substance represented the acquisition of additional rights for Taiwan, South Korea, and Vietnam.

As part of the License Agreement, the Company entered into a common stock purchase agreement with Soligenix pursuant to which the Company bought 3,529,412 shares of Soligenix common stock. These common shares are unregistered but the Company has demand registration rights and can compel a registration of the securities in a reasonably short time in the event the Company plans to sell the shares. The total cash consideration of $3,000,000 paid to Soligenix at the time of the transaction reflected the purchase price of the common stock and the consideration for expanded territorial rights in South Korea, Taiwan , and Vietnam.

As of the transaction date, the common stock was recorded at an initial fair value of $2.7 million representing publicly quoted closing share prices from the OTCQB, the over-the-counter market on which Soligenix’s securities were listed at the time. The residual cash consideration of $0.3 million related to the expanded territorial rights was recorded as research and development expense in the third quarter of fiscal 2016.

13


 

The Company is holding the Soligenix shares in the context of a business relationship, and as such has classified them as available-for-sale. The common stock investment is adjusted to fair value at each reporting date with unrealized gains (losses) reported as a component of other comprehensive income (loss).

In October 2016, in connection with an up-listing of its stock from the OTCQB market to the NASDAQ Common Market, Soligenix declared a 1 for 10 reverse stock split, converting the Company’s ownership in Soligenix from 3,529,412 shares to 352,942 shares. As of June 30 , 2017, the fair value of the Soligenix common stock investment was $ 0.7 million and the unrealized holding loss on the investment was $ 2.0 million, which was recorded as a component of other comprehensive loss (net of tax, which is zero as the entity holding the security is in a zero-tax jurisdiction) . The Company considered whether the decline in fair value was an other than temporary impairment (OTTI), and determined that the decline in fair value was temporary after considering the volatility of the common stock , external research reports and market expectations, and other investee-specific facts and circumstances. In particular, the investee’s share price increased in the first qua rter of 2017 by $159,000, and decreased by $229,000 in the second quarter, with a cumulative net decrease of $70,000 in the first six months of 2017.

Note 5 —   Loans Receivable

As part of the Company’s May 2013 license and supply agreement with Zensun (Shanghai) Science & Technology Co. Ltd (together with any successors or assigns, “Zensun”), the Company previously agreed to loan up to $12 million to Zensun. The entry into the license and supply agreement in the second quarter of 2013, pursuant to which the Company licensed the exclusive rights to promote, market, distribute, and sell Neucardin TM , a chronic heart failure product under development by Zensun (such rights licensed for the People’s Republic of China, Hong Kong and Macao) is more fully described in the Company’s Annual Report on Form 10-K for th e fiscal year ended December 31 , 2016 (the “2016 Form 10-K”) , Note 13.  

Pursuant to its agreement to loan funds, the Company loaned $12 million to Zensun. The extension of credit and funding to Zensun was accomplished through two of the Company's subsidiaries, SPIL China and SciClone Pharmaceuticals (China) Ltd. (“SciClone China”).

With respect to lender SciClone China, Zensun can make RMB-denominated borrowings for up to RMB 1,550,000 using an entrustment mechanism with a bank as an intermediary. In the third quarter of 2014, SciClone China entered into an entrusted loan agreement for RMB 1,550,000 (approximately US$ 229 ,000 as of   June 30 , 2017) with Zensun, using a major Chinese bank as the lending agent. SciClone China is the principal and ultimately bears the credit risk, not the bank. The loan bears interest at a fixed rate of 7.5% per annum and Zensun is subject to obligations of the borrower as specified in the loan agreements. The loan term is sixty-six months. All outstanding principal and interest balances must be repaid by the maturity date, with prepayments permitted without penalty upon prior notice.

With respect to lender SPIL China, Zensun could request U.S. dollar denominated borrowings up to $11.75 million. As of June 30 , 2017, borrowings totaling $11.75 million had been requested by Zensun and paid by SPIL China with $4.5 million lent in the second half of 2014 and $7.25 million lent in the second quarter of 2015. These borrowings bear interest at a fixed rate of 7.5% per annum payable annually in arrears at each interest payment date as defined in the overall loan agreement. These borrowings were originally scheduled to mature on September 26, 2017 , with an option (granted at loan origination) electable by Zensun to extend for two additional years provided certain conditions are met. A s of June 30 , 2017, the borrower had notified the Company of its intent to exercise its option to extend the borrowings for two additional years, or to September 26, 2019 . A ll outstanding balances must be repaid by the maturity date, with prepayments permitted without penalty upon prior notice.

The proceeds of the two separate but related loans are to be used for working capital and general corporate purposes by Zensun. To secure the loans, Zensun pledged its entire equity interest in its subsidiary, Shanghai Dongxin Biochemical Technology Co. Ltd. (whose assets include real property) to SPIL China.

Management, on the basis of (i) a creditworthiness evaluation using recent Zensun financial information, (ii) consideration of evidence of the market value of the pledged security indicating such market value exceeded the outstanding loan principal, and (iii) consideration of Zensun’s compliance with the terms of the loans and timely payments of interest, concluded t hat t here were no i ndications of loan impairment as of   June 30 , 2017 or December 31, 2016 .  Accordingly, no allowance for losses was recorded.

The two loans are included in “other assets” on the Company’s unaudited condensed consolidated balance sheet s as of June 30 , 2017 and December 31, 2016. Interest income on the loans amounted to $ 0.2 million and $0.2 million for the three months ended June 30 , 2017 and 2016, respectively, and is included in interest and investment income in the unaudited condensed consolidated statements of income.  I nterest income on the loans amounted to $ 0.5 million and $0.5 million for t he six months ended June 30 , 2017 and 2016, respectively, and is included in interest and investment income in the unaudited condensed consolidated statements of income.

14


 

Note 6  —   Goodwill

The following table represents the changes in goodwill for the s i x months ended June 30 , 2017  ( in thousands ):



 

 

Balance as of December 31, 2016

$

30,838 

Translation adjustments

 

754 

Balance as of June 30, 2017

$

31,592 



 

 



 







Note 7 Accrued and Other Current Liabilities

Accrued and other current liabilities consisted of the following   (in thousands):



 

 

 

 

 

 



 

 

 

 

 

 



 

June 30,

 

December 31,



 

2017

 

2016

Accrued sales and marketing expenses

 

$

6,932 

 

$

8,623 

Accrued taxes, tax reserves and interest

 

 

6,157 

 

 

5,335 

Accrued compensation and benefits

 

 

3,044 

 

 

5,140 

Accrued professional fees

 

 

1,442 

 

 

1,298 

Accrued manufacturing costs

 

 

1,712 

 

 

715 

Other

 

 

1,275 

 

 

1,685 



 

$

20,561 

 

$

22,796 



   



Note 8 — Accumulated Other Comprehensive Income ( Loss )

Changes in the composition of accumulated other comprehensive income (loss) f or the three and six months ended June 30 , 2017 and 2016 are as follows ( in thousands ):









 

 

 

Balances as of April 1, 2017

 

$

(1,139)

Other comprehensive loss — unrealized loss on available-for-sale investment in common stock of third party

 

 

(229)

Other comprehensive income — foreign currency translation

 

 

466 

Balances as of June 30, 2017

 

$

(902)







 

 

 

Balances as of April 1, 2016

 

$

2,267 

Other comprehensive loss — foreign currency translation

 

 

(787)

Balances as of June 30, 2016

 

$

1,480 









 

 

 

Balances as of January 1, 2017

 

$

(1,520)

Other comprehensive loss — unrealized loss on available-for-sale investment in common stock of third party

 

 

(70)

Other comprehensive income — foreign currency translation

 

 

688 

Balances as of June 30, 2017

 

$

(902)







 

 

 

Balances as of January 1, 2016

 

$

2,070 

Other comprehensive loss — foreign currency translation

 

 

(590)

Balances as of June 30, 2016

 

$

1,480 



 

 

 



 









15


 

Note 9 — Stockholders’ Equity

Stock-based Compensation

The Company adopted ASU 2016-09, “Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which outlines new provisions intended to simplify various aspects related to accounting for share-based payments and their presentation in the financial statements beginning January 1, 2017. Under the amended guidance, the Company has elected to account for forfeitures as they occur, instead of continuing to estimate forfeitures, as previously required. The new forfeiture guidance was adopted using a modified   retrospective approach , resulting in t he Company recording   a   $ 133,000 cum ulative effect charge to accumulated deficit for the difference between the amount of compensation cost previously recorded and the amount that would have been recorded without assuming forfeitures.

The following table summarizes the stock-based compensation expenses included in the unaudited condensed consolidated statements of income ( in thousands ):



 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



 

2017

 

2016

 

2017

 

2016

Sales and marketing

 

$

326 

 

$

233 

 

$

602 

 

$

442 

Research and development

 

 

149 

 

 

56 

 

 

249 

 

 

108 

General and administrative

 

 

1,707 

 

 

887 

 

 

3,002 

 

 

1,919 



 

$

2,182 

 

$

1,176 

 

$

3,853 

 

$

2,469 

Stock Options

During the six months ended June 30 , 2017 , the Company granted options to purchase a total of 1,365,500 shares of common stock with a weighted-average grant-date fair value of $ 4. 27 per share   option granted , and options to purchase 809,341 shares of common stock were exercised ;   resulting in total cash proceeds of $ 3.4 million . As of June 30 , 201 7 , there was approximately $ 10. 7 million of unrecognized compensat ion expense related to non-vested stock options, which is expected to be recognized over a weighted-average remaining period of approximately 2.7   years.

Restricted Stock Units (RSUs)   and Restricted Performance Stock Units (PSUs)

During the six months ended June 30 , 2017 ,   77,000 RSUs and 150,000 PSUs were granted at a grant date fair value per share of $ 9.65 , and   165,000 RSUs vested. The PSUs will vest and be released on meeting performance goals within an established time frame.   If the performance goals are not met within the established time frame, the PSUs will expire. The Company recognizes expense related to the PSUs over the period of time the Company determines that it is probable that the performance goals will be achieved. If it is subsequently determined that the performance goals are not probable of achievement, the expense related to the PSUs is reversed.   As of June 30 , 2017 , there was approximately $ 2.9 million of unr ecognized compensation cost related to non-vested RSUs, which is expected to be recognized over a weighted-average remaining period of approxima tely 1.4 ye ars.    

Note 10  —   Commitments   and Contingencies

Under agreements with certain of the Company’s pharmaceutical partners, the Company is committed to certain annual minimum product purchases where the contract is subject to termination if the an nual minimum order is not met. As of June 30 , 2017 , the Company did not have any material unmet purchase obligations.

Legal Matters

NovaMed Shanghai , one of the Company’s China subsidiaries, was a party to a Distribution and Supply Agreement with MEDA Pharma GmbH & Co. KG (“MEDA”). Following the Company’s acquisition of NovaMed Shanghai, MEDA claimed it had a right to terminate the agreement under a change of control provision. NovaMed Shanghai does not believe that MEDA had a right of termination under the agreement. As of February 24, 2017, NovaMed Shanghai entered into a settlement agreement with MEDA to resolve all outstanding claims of each party under the Distribution and Supply Agreement, including as related to the China International Economic and Trade Arbitration Commission (“CIETAC”) arbitration in which NovaMed Shanghai had been claiming r emuneration of services and certain reimbursement amounts. Per the terms of the settlement agreement, MEDA paid NovaMed Shanghai $83,333 on March 7, 2017, NovaMed Shanghai withdrew its “Request for Second Arbitration” with CIETAC, and the CIETAC arbitral tribunal dismissed the arbitration case.





16


 





Note 11 — Income Taxes

The provision for income taxes for the three months ended June 30, 2017, was approximately $0.6 million compared with $0.4 million of income tax benefits for the three months ended June 30, 2016. In the three months ended June 30, 2017, we booked $1.1 million of additional tax expense representing expected deferred tax liabilities which arose as a consequence of a change in our position regarding reinvestment of certain offshore undistributed earnings of our foreign subsidiaries, which is further described in Note 11 – Income Taxes. Without this $1.1 million of additional tax expense, we would have approximately $0.5 million income tax benefit for the three months ended June 30, 2017 compared to $0.4 million income tax benefit for the three months ended June 30, 2016. The benefit for income taxes relate to a reduction in the Company’s liabilities for uncertain tax positions in China due to certain tax years becoming closed to assessment due to the statute of limitations.



The provision for income taxes for the six months ended June 30, 2017, was approximately $1.6 million compared with $1.6 million for the six months ended June 30, 2016. In the six months ended June 30, 2017 we booked $1.1 million of additional tax expense representing expected deferred tax liabilities which arose as a consequence of a change in our position regarding reinvestment of certain offshore undistributed earnings of our foreign subsidiaries, which is further described in Note 11 – Income Taxes. In the six months ended June 30, 2016 we booked $1.2 million of additional income tax expense, and recorded a corresponding accrual in accrued and other current liabilities, to correct an error. The error correction reflected the recognition of a previously unrecognized liability for an uncertain tax position related to the potential non-deductibility, under PRC tax regulations, of certain marketing costs related to the Company’s China operations, which is described in further detail in Note 1, “Error Corrections.” The Company’s tax statutory tax rate in China was 25% in 2017 and 2016.

The Company had previously concluded, up to the second quarter of 2017, that its offshore undistributed accumulated earnings as of December 31, 2016 of $249   million were indefinitely reinvested and had therefore provided no taxes thereon. The Company had also previously concluded, in conjunction with this assertion, that a portion of its earnings expected to be generated by foreign subsidiaries in 2017 would be repatriated to the parent company in order to address the parent company’s liquidity needs.

The Company entered into a definitive merger agreement (subject to stockholder approval and other customary closing conditions) in the second quarter of 2017 with a consortium of buyers intending to acquire the Company in a “goin g-private” transaction ( announced via a Form 8- K filed with the SEC on June 8, 2017). The terms of the definitive merger agreement, among other provisions regarding the funding of the acquisition, provide that the Comp any may distribute funds from its foreign subsidiaries (Cayman Islands entities) to the United States par ent company in order to commit a portion of the merger funds necessary to effect the “going private” transact ion and repurchase common sh ares. As a result of this contractual provision, the Company concluded in Q2 that the likelihood of distribution of offshore undistributed earning s cast doubt upon the ability to indefinitely reinvest of fshore undistributed earnings. Accordingly, following consideration of amounts specified in the merger agreement and related agreements, it was concluded that $123 million of the unremitted earnings are no longer indefinitely reinvested as a result of expected distribution before the close of the announced merger in late 2017. The Company determined, after further analysis, that its parent company’s available tax net operating loss carryforwards , which had been fully reserved via valuation allowances, are available to eliminate tax liability associated with substantially all of the Federal taxable dividend income of $123 million that would arise f rom a planned remittance. After dete rmination of the amount, the C ompany recorded additional net tax expense of approximately $1.1 million as a discrete tax charge in the second quarter of 2017 for the full estimated US tax cost associated with t he expected remitt ance of such earnings .   The net expense represent s the Federal deferred tax liability associat ed with the planned remittance, substantially offset by the reversal of the associated valuation allowance on the tax net operating loss carryfor wards expected to be utilized. No withholding taxes are anticipated for the planned remittance due to the jurisdictions in which the cash expected to be remitted is held.

The Company evaluated its remaining offshore undistributed earnings of $126 million (after excluding the anticipated $123 million dividend distribution) and after further consideration of business needs in its foreign subsidiaries and the lack of further needs by its parent company concluded it has the intent and ability to indefi nitely reinvest the remainder. Accordingly, no deferred taxes have been provided for the remaining unremitted earnings; determination of the amount of such taxes on the remainder is not practicable given substantial complexity stemming from the various jurisdictions involved, tax attributes to be considered, time periods involved, and withholding taxes that may need to be considered.

Note 12 — Segment Information and Geographic Data

The Company reports segment information based on the internal reporting used by management for evaluating segment performance based on management’s estimates of the appropriate allocation of resources to segments.

T he Company operates and manages its business primarily on a geographic basis. Accordingly, the Company determined its operating segments and reporting units, which are generally based on the nature and location of its customers, to be 1) China, and 2) Rest of the World, including the U . S . and Hong Kong.

17


 

The Company evaluates the performance of its operating segments based on revenues and operating income (loss). Revenues for geographic segments are generally based on the location of customers. Operating income (loss) for each segment includes revenues, related cost of sales and operating expenses directly attributable to the segment. Operating income (loss) for each segment excludes non-operating income and expense.  

Summary information by operating segment for the three and six month periods ended June 30 , 2017 and 201 6 is as follows ( in thousands ):



 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



 

2017

 

2016

 

2017

 

2016

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

42,561 

 

$

37,257 

 

$

82,489 

 

$

72,127 

Rest of the World (including the US and Hong Kong)

 

 

1,959 

 

 

1,734 

 

 

4,923 

 

 

3,363 

Total net revenues

 

$

44,520 

 

$

38,991 

 

$

87,412 

 

$

75,490 

Income (loss) from operations:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

17,581 

 

$

13,314 

 

$

35,083 

 

$

26,654 

Rest of the World (including the US and Hong Kong)

 

 

(5,264)

 

 

(7,361)

 

 

(8,529)

 

 

(11,277)

Total income from operations

 

$

12,317 

 

$

5,953 

 

$

26,554 

 

$

15,377 

Non-operating income (loss), net:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

446 

 

$

18 

 

$

1,799 

 

$

394 

Rest of the World (including the US and Hong Kong)

 

 

18 

 

 

(4)

 

 

36 

 

 

Total non-operating income, net

 

$

464 

 

$

14 

 

$

1,835 

 

$

401 

Income (loss) before provision for income tax:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

18,027 

 

$

13,332 

 

$

36,882 

 

$

27,048 

Rest of the World (including the US and Hong Kong)

 

 

(5,246)

 

 

(7,365)

 

 

(8,493)

 

 

(11,270)

Total income before provision for income tax

 

$

12,781 

 

$

5,967 

 

$

28,389 

 

$

15,778 



Long-l ived assets by operating segment as of June 30 , 2017 and December 31, 2016 are as follows ( in thousands ):



 

 

 

 

 

 



 

June 30,

 

December 31,



 

2017

 

2016



 

 

 

 

 

 

China

 

$

45,096 

 

$

44,603 

Rest of the World (including the US and Hong Kong)

 

 

1,507 

 

 

1,562 



 

$

46,603 

 

$

46,165 























18


 

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 "may," "will," "would," "could," "should," "might," "believes," "estimates," "projects," "potential," "expects," "plans," "anticipates," "intends," "continues," "forecast," "designed," "goal," “approximately” or the negative of those words or similar expressions are intended to identify forward-looking statements, including those statements we make regarding our future financial results. These statements are subject to risks and uncertainties that are difficult to predict and actual outcomes may differ materially.

These include risks and uncertainties relating to:  

·

our substantial dependence on sales of ZADAXIN in China and renewal of our Import Drug License with respect to ZADAXIN;

·

government regulatory action affecting our Company or our drug products or our competitors' drug products in China, the U.S. and other foreign countries, including the effect of government initiatives in China, particularly the Chinese government’s increasing regulation of the pharmaceutical industry through anti-corruption activities;

·

Chinese government regulatory actions intended to reduce pharmaceutical prices such as the reduction in some provinces of the governmentally permitted maximum listed price for our products and increased oversight of the health care market and pharmaceutical industry;

·

prospects for ZADAXIN and our plans for its enhancement and commercialization as well as our expectations regarding other products;

·

future size of the oncology, cardiovascular, hepatitis B virus (“HBV”) and hepatitis C virus (“HCV”) and other markets, particularly in China ;

·

anticipated product sales of current or anticipated products;

·

the sufficiency of our resources to complete clinical trials and other new product development initiatives; government regulatory actions that may affect product reimbursement, product pricing or otherwise affect the s cope of our sales and marketing, and the timing and outcome of clinical trials;

·

t he dependence of our current and future revenue and prospects on third-party license, promotion or distribution agreements, including the need to renew such agreements, enter into similar agreements, or end arrangements that SciClone does not believe are beneficial;

·

the effects of the resolved U.S. Securities and Exchange Commission (“SEC”) and U.S. Department of Justice (“ DOJ ”) investigations and our ability to continue to comply with applicable laws and regulations, and carry out the continued reporting responsibilities agreed to with the SEC;

·

announcement and completion of corporate acquisition, merger, licensing or marketing arrangements, or sales of assets ;

·

our ability to implement and maintain controls over our financial reporting;

·

operating an international business, particularly in China including pricing regulations, slow payment cycles and currency exchange fluctuations;

·

uncertainty in the prospects for unapproved products, including uncertainties as to pricing and competition and risks relating to the clinical trial process and related regulatory approval process and the process of initiating trials at, and enrolling patients at, clinical sites;

·

research and development and other expense levels;

·

the ability of our suppliers to continue financially viable production of our products;

·

the allocation of financial resources to certain trials and programs, and the outcome and expenses related to litigation; and

·

other factors discussed in this Report in Part I, Item 2 “Management Discussion and Analysis of Financial Condi tion and Results of Operations” and Part II, Item 1A “Risk Factors ”.

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 and under the same caption in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

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Table of Contents

 

Overview  

SciClone Pharmaceuticals, Inc. (NASDAQ: SCLN) is a United States (“U.S.”)-headquartered, China-focused, specialty pharmaceutical company with a substantial commercial business and a product portfolio of therapies for oncology, infectious diseases and cardiovascular disorders. We are focused on continuing to grow our revenue and profitability. Our business and corporate strategy is focused primarily on the People’s Republic of China (“China” or “PRC”) where we have built a solid reputation and established a strong brand through many years of experience marketing our lead product, ZADAXIN ®   (thymalfasin). In addition, we have an established business model with large pharmaceutical partners to promote and sell products. We believe our sales and marketing strengths position us to benefit from the long-term expansion of the pharmaceutical market in China. We seek to expand our presence in China and increase revenues by growing sales and profits of our current product portfolio, launching new products from our development pipeline, adding new, profitable product services agreements and leveraging our strong cash position to in-license additional products.

On June 7, 2017, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Silver Biotech Investment Limited, a company organized under the laws of the Cayman Islands (“Holdco”), and Silver Delaware Investment Limited, a Delaware corporation and a wholly-owned subsidiary of Holdco (“Merger Sub”), under which Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing after the Merger as the surviving corporation and subsidiary of Holdco.  Holdco and Merger Sub were formed by a consortium affiliated with GL Capital Management GP Limited, Bank of China Group Investment Limited, CDH Investments, Ascendent Capital Partners and Boying.  

At the effective time of the Merger (the “Effective Time”), each share of the Company’s common stock, par value $0.001 per share (the “Common Stock”), issued and outstanding immediately prior to the Effective Time (other than (i) shares of the Common Stock that are held by the Company, Holdco or Merger Sub or any direct or indirect wholly-owned subsidiary of either the Company or Holdco, including the shares held by GL Capital, and (ii) certain shares of the Common Stock with respect to which the holder thereof shall have properly complied with the provisions of Section 262 of the General Corporation Law of the State of Delaware as to appraisal rights) shall be converted into the right to receive $11.18 in cash, without interest.

The transaction, which was unanimously approved by SciClone’s Board, is expected to close this calendar year, subject to approval by SciClone stockholders and other customary closing conditions.

Additional information about the Merger Agreement and the related transactions can be found in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 8, 2017.

We operate in two segments which are generally based on the nature and location of our customers: 1) China and 2) the Rest of the World, which includes our U.S. and Hong Kong operations.

We have two categories of revenues: “product sales revenues” and “promotion services revenues.” Our product sales revenues result from our proprietary and in-licensed products, including our lead product, ZADAXIN; DC Bead ® ,   a product for the embolization of malignant hypervascularized tumors, and oncology products from Pfizer International Trading (Shanghai) Ltd. (“Pfizer”). ZADAXIN has the highest margins in our portfolio as it is a premium product sold exclusively by SciClone. Our “promotion services revenues” result from fees we receive for exclusively promoting oncology and cancer supportive care products in China for Baxter International, Inc. (“Baxter”). We recognize promotion services revenues as a percentage of our collaborator’s product sales revenue for these exclusively promoted products. 

ZADAXIN is approved in over 30 countries and may be used for the treatment of HBV, HCV, and certain cancers, and as an immune system enhancer according to the local regulatory approvals we have in these countries. In China, thymalfasin is included in the treatment guidelines issued by the Ministry of Health (“MOH”) for liver cancer, as well as guidelines for treatment of chronic HBV (issued by both the Chinese Medical Association and the Asian-Pacific Association for the Study of the Liver) and invasive fungal infections of critically ill patients (issued by the Chinese Medical Association). Our sales force is focused on increasing sales to the country’s largest hospitals (class 3A with over 500 beds) as well as mid-size hospitals (class 2A). These hospitals serve Tier 1 and Tier 2 cities located mostly in the eastern part of China, which are the largest and generally have the most affluent populations. We are widening our market strategies by piloting e-commerce approaches to reach customers. We are also seeking to expand the indications for which ZADAXIN could be used, including sepsis, and in September 26, 2016, we announced the first patient has been treated in a clinical trial for sepsis using ZADAXIN in China.

We initiated sales and recorded our first product revenue from DC Bead in the third quarter of fiscal 2015. The China Food and Drug Administration had approved the registration of DC Bead for the embolization of malignant hypervascularized tumors in August 2014. DC Bead may be used to treat liver cancer, a large and growing indication in China.

We are also pursuing the registration of Loramyc ® , a mucoadhesive tablet formulation of miconazole lauriad to treat oropharyngeal candidiasis.

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Table of Contents

 

Our agreement with Baxter is for a 5-year term, through December 2017, and our agreement with Pfizer is for a 5-year term, through June 2019. We continue to seek in-licensing arrangements for well-differentiated products at various stages of development that, if not yet approved, have a defined regulatory approval pathway in China, to increase our revenues and profitability. We have in-license agreements for the following products:

Our In-Licensed Drug Candidates in Clinical Development Include the Following:

PT-112 : On September 26, 2016, we announced the first patient has been treated in the Phase 1 proof-of-concept trial of PT-112, a multi-targeted platinum-pyrophosphate anticancer agent being developed for patients with advanced solid tumors, in Taiwan. PT-112 is a key early-stage asset supporting our strategy to expand our oncology portfolio and drive long-term growth. We obtained, in 2015, exclusive development and commercialization rights from Phosplatin Therapeutics to PT-112 for Greater China (mainland China, Hong Kong, and Macau) , and Vietnam, along with the exclusive option to expand the territory to include South Korea , and Taiwan.

SGX942 : On September 12, 2016, we and Soligenix, Inc. announced that we entered into an exclusive license agreement granting rights to SciClone to develop, promote, market, distribute and sell SGX942 (dusquetide), a novel, first-in-class therapy being developed for the treatment of oral mucositis in patients with head and neck cancer. The licensing agreement includes the PRC, Hong Kong, Macau, Taiwan, South Korea , and Vietnam (the “Territory”). This exclusive agreement builds on an existing collaboration, in which we provided our complete oral mucositis clinical and regulatory data library to Soligenix in exchange for certain, previously undisclosed, commercialization rights to SGX942 in the Greater China market (the “2013 exchange”). The Phase 2 results reported by Soligenix, Inc. showed a significant reduction in the duration of severe oral mucositis in patients receiving chemoradiation therapy for treatment of their head and neck cancer.

Under the terms of the agreement, we transferred cash consideration of $3 million to Soligenix for 3,529,412 shares of Soligenix common stock and expanded rights for SGX942 in Taiwan, South Korea, and Vietnam, as we had previously obtained rights for Greater China in the 2013 exchange. In October 2016, Soligenix announced a 1 for 10 reverse stock split resulting in the Company’s ownership of 352,942 shares. In addition, we will be responsible for all aspects of development, product registration and commercialization in the Territory, having access to data generated by Soligenix. In the future, we will pay to Soligenix royalties on net sales, and Soligenix will supply commercial drug product to us on a cost-plus basis, while maintaining worldwide manufacturing rights.

VIBATIV ®   (telavancin): In May 2015, Theravance Biopharma, Inc. (“Theravance Biopharma”) granted SciClone exclusive development and commercialization rights to VIBATIV   (telavancin) in China, Hong Kong, Macao, Taiwan , and Vietnam, in exchange for upfront and regulatory milestone payments totaling $6 million. SciClone will be responsible for all aspects of development and commercialization in the partnered regions, including pre- and post-launch activities and product registration. SciClone will initially develop VIBATIV for hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia, and additional indications may include complicated skin and skin structure infections and potentially bacteremia. Theravance Biopharma will sell to SciClone all clinical and commercial product required to develop and commercialize VIBATIV in China and our other licensed territories. We anticipate commencing a bridging trial for VIBATIV.

Angiomax ®   (bivalirudin) and Cleviprex ®   (clevidipine ):   In December 2014, we entered into a strategic partnership with The Medicines Company. The partnership includes an agreement granting us a license and the exclusive rights in China to promote two cardiovascular products including 1) Angiomax   (bivalirudin) for Injection, an anticoagulant indicated in patients undergoing percutaneous coronary intervention (PCI) with provisional use of glycoprotein IIb/IIIa inhibitor (GPI) and in patients with, or at risk of, heparin-induced thrombocytopenia and thrombosis syndrome undergoing PCI and 2) Cleviprex   (clevidipine) Injectable Emulsion, a third-generation dihydropyridine calcium channel blocker indicated for the reduction of blood pressure when oral therapy is not feasible or desirable. 

For Angiomax, a Phase 3 registration trial was completed in China. We also completed, for Angiomax, a Clinical Trial Application (“CTA”) approval and a Clinical Trial Waiver with the China Food and Drug Administration (“CFDA”) in December 2016, and are in the process of preparing a New Drug Application (“NDA”) with respect to Angiomax .  

For Cleviprex, a CTA for China was filed in 2013. We received CTA approval from the CFDA in early 2016 and had been preparing a clinical study with respect to Cleviprex. Chiesi USA, Inc. and its parent company, Chiesi Farmaceutici S.p.A. (“Chiesi”), acquired the rights to Cleviprex in June 2016 from the Medicines Company.  SciClone has decided not to continue proceeding with the preparation of a clinical study with respect to Cleviprex and is evaluating options with respect to the program, including exploring potential opportunities to out-license SciClone’s rights with respect to Cleviprex.

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Table of Contents

 

Under the terms of the agreements for Angiomax and Cleviprex, which also apply to Chiesi for Cleviprex, we have the rights to, and will be responsible for all aspects of commercialization, including pre-and post-launch activities, for both products (Cleviprex and Angiomax) in the China market (excluding Hong Kong and Macao). We had also agreed to initially participate in the China registration process for both products. Financial terms of the agreements for the two products, in addition to net sales royalties payable to The Medicines Company and/or Chiesi, include the following additional payments to The Medicines Company and/or Chiesi: an upfront payment made in the fourth quarter of 2014; a project support services fee; and regulatory/commercial success milestone payments of up to an aggregate of $50.5 million.  

Neucardin TM : In May 2013, we entered into a framework agreement with Zensun for the exclusive promotion, marketing, distribution and sale of Neucardin in China, Hong Kong and Macao. Neucardin is a novel, first-in-class therapeutic for the treatment of patients with intermediate to advanced heart failure, for which an NDA was submitted to and accepted for review by the CFDA in 2012. In December 2013, the CFDA informed Zensun that its Phase 2 data is insufficient, and has asked Zensun to submit a new NDA once the ongoing Phase 3 study reached its endpoints. As part of our agreement with Zensun, we agreed to loan up to $12 million to Zensun, of which $12 million had been loaned as of December 31, 2016 (refer to Note 5 to the condensed consolidated financial statements appearing under Part I, Item 1 for further information regarding the Zensun loans).

ABTL-0812 : Our license agreement with Ability Pharmaceuticals SL grants us a license and the exclusive rights to develop, manufacture and commercialize ABTL-0812 in China, Macau, Hong Kong, Taiwan, and Vietnam. ABTL-0812 is a first-in-class P13K/Akt/mTOR signaling pathway inhibitor for solid tumors, important in regulating the cell cycle. We are currently preparing for a phase 1 proof-of-concept trial in Taiwan and Mainland China.

Governmental Policy Changes in China

Governmental policy changes in China have eliminated national regulation of the maximum retail drug prices for most drugs effective as of June 1, 2015. Decisions by provincial authorities appear to be emerging as the primary governmental mechanism for price controls. As an example, the Zhejiang provincial authority announced a price limitation for sales of ZADAXIN in the province in April 2015 that became effective in May 2015. We were able to mitigate the impact of this price limitation by shifting an equitable portion of the burden of the price reduction and the benefit of higher pricing in provinces with higher tender prices with our distributor in our sales channel. Under our new contractual arrangement with Sinopharm, effective January 1, 2016, the lower tender price is reflected in a lower base invoice price to Sinopharm, as further described in the following section under “Results of Operations, Revenues ”. We anticipate that provincial pricing decisions will continue to be a significant factor in the China pharmaceutical market for the foreseeable future.

Recently, Guangdong and Fujian provinces have each announced maximum prices for ZADAXIN that are approximately six and four percent lower, respectively, than the reference (baseline)   tender price . We expect these provincial decisions to affect the pricing of ZADAXIN in these pro vinces with respect to sales mad e pursuant to contracts dated on and after March 2017 for Guangdong and Fujian , and to affect pricing in other provinces, but the exact timing and consequences to our pricing, especially in other provinces, is uncertain. For the quarter ended June 30 , 2017, G uangdong and Fujian represented a pproximately 13.4% and 3% , respectively, of our ZADAXIN volume s in China. We have estimated for the second quarter that   $0.8 million of price compensation will be payable to distributors for ZADAXIN   product to be sold at prices in these two provi nces below the reference tender price under a provision in the agreement with the Company’s China distributor.   This amount, therefore, was recorded as a reduction to revenue in our second quarter results of operations. The impact of such pricing decisions on our future results is unpredictable, but we expect that pricing pressures on revenue in 2017 will be offset through sharing of the burden with our China distributor and potentially through volume increases. However, in the future, prices could be reduced to levels significantly below those that would prevail in an unregulated market, which may limit the growth of our revenues or cause them to decline.

In February 2017 , a new National Reimbursement Drug List (“N R D L”) was issued by Chinese government authorities, and included thymalfasins as “Type B” drugs which are partially reimbursed; however , Hepatitis B was not listed as an indication for thymalfasins in the new N R D L. Partial reimbursement for Hepatitis B and other indications could also be obtained by provinces determining to list thymalfasins on Provi ncial Reimbursement Drug Lists (“PRDLs”) which we expect to be relea sed in the second half of 2017. The Company will be seeking to have thymalfasins listed in PRDLs including for the He patitis B and cancer indication . Although thymalfasin is no longer covered unde r the Basic Medical Insurance, reimbursement under worke r’s compensation coverage remains in place.

We believe our cash and cash equivalents as of June 30 , 2017 and ongoing revenue gene rating business operations will be sufficient to support our current operating plan for at least the next 12 months beyond the issuance date. Our results may fluctuate from quarter to quarter and we may report losses in the future.

22


 

Table of Contents

 

Results of Operation s

Revenues :

The following table summarize s the period over period change in our product sales and promotion services (in thousands):  





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

Three Months Ended

  

 

 

Six Months Ended

  

 



 

June 30,

 

 

 

June 30,

 

 



  

2017

  

2016

  

Change

 

2017

  

2016

  

Change

Product sales, net

 

$

43,369 

  

$

37,869 

  

15% 

 

$

85,006 

  

$

73,189 

  

16% 

Promotion services

 

 

1,151 

 

 

1,122 

 

3% 

 

 

2,406 

 

 

2,301 

 

5% 

Total net revenues

 

$

44,520 

 

$

38,991 

 

14% 

 

$

87,412 

 

$

75,490 

 

16% 



Product sales were $43.4 million for the three month period ended June 30, 2017 compared to $37.9 million for the corresponding period in 2016, an increase of $5.5 million, or 15%. ZADAXIN sales were $41.6 million in the second quarter of 2017, compared to $36.5 million for the same period in 2016, a $5.1 million or 14% increase. An increase of $4.4 million was attributed to an increase in volumes of 12%,  an increase of $3.3 million was attributed to revenues from sales generated in the first quarter of 2017 but recognized only in the second quarter of 2017 that were above the reference tender price under a provision in the agreement with the Company’s China distributor, a revenue decrease of $0.8 million was attributed to ZADAXIN products sold in the second quarter that we estimate will be ultimately sold at prices below the reference tender price under a provision in the agreement with the Company’s China distributor, and a revenue decrease of $1.8 million was attributed to an unfavorable exchange rate since last year.

Product sales were $85.0 million for the six month period ended June 30, 2017 compared to $73.2 million for the corresponding period in 2016, an increase of $11.8 million, or 16%. ZADAXIN sales were $81.1 million for the six month period ended June 30, 2017, compared to $70.1 million for the corresponding period of 2016, an increase of $11.0 million or 16%, An increase of $10.2 million was attributed to an increase in volumes of 15%,  an increase of $7.5 million was attributed to revenues from sales generated in the fourth quarter of 2016 and in the first quarter of 2017 but recognized only in the first and second quarters of 2017 that were both above the reference tender price under a provision in the agreement with the Company’s China distributor, a revenue decrease of $0.8 million was attributed to ZADAXIN products sold in the second quarter that we estimate will be ultimately sold at prices below the reference tender price under a provision in the agreement with the Company’s China distributor, and a revenue decrease of $5.9 million was attributed to an unfavorable exchange rate since last year .  



As of June 30, 2017, approximately $44.7 million, or 93%, of the Company's accounts receivable was attributable to one customer, Sinopharm, in China. The Company generally does not require collateral from its customers. The Company maintains reserves for potential credit losses and such actual losses may vary significantly from its estimates.

Our contractual arrangement with Sinopharm which commenced January 1, 2016 is resulting in the later recognition (relative to practices prevailing through December 31, 2015) of a portion of our revenue invoiced to Sinopharm in situations where the provincial tender price is greater relative to a reference (baseline) tender price. This is due to a price adjustment mechanism in the new contractual arrangement whereby Sinopharm is invoiced at a lower base price relative to that prevailing in the previous agreement. The lower base price (reduced by estimated price compensation payable to the distributor for situations where the provincial tender price is lower than the reference (baseline) tender price) is recorded as revenue at the time the sale is completed the goods arrive at destination. Sinopharm is invoiced for the portion of the price that may result from situations where the provincial tender price is greater than the reference (baseline) tender price at a later time, and that portion will be recognized as revenue after the amount has been agreed upon with them. Although we do not expect this new arrangement to have a significant impact on annual revenue or the amount recognized on an annual basis, it has and may continue to impact our current and future quarterly revenue amounts and timing. For example, the price compensation receivable due to us from Sinopharm for above-reference tender price provinces for products originally sold in the first quarter of 2016 was recognized in the third quarter of 2016, and the amount of price compensation receivable for products originally sold in the second and third quarters of 2016 was recognized in the fourth quarter of 2016. We expect that the price compensation receivable due to us from Sinopharm for above-reference tender price provinces for a quarter will be recognized on a one-to-two quarter delayed basis relative to the originating sales quarter going forward. We expe ct that such price compensation receivable, on an estimated basis, will be recognized in the originating sales quarter rather than a later quarter when it is agreed with the distributor under the provisions of ASU 2014-09 (the new revenue recognition guidance which takes effect from January 1, 2018 for us).

Per our previous contractual arrangement with Sinopharm through December 31, 2015, and the aforementioned renewed contractual arrangement with Sinopharm (our sole importer and distributor for ZADAXIN in China) which took effect January 1, 2016, our sales of ZADAXIN to Sinopharm were denominated in U.S. dollars through June 30, 2016. However, the established importer price was adjusted quarterly based upon exchange rate fluctuations between the U.S. dollar and RMB. Effective July 1, 2016, our sales of ZADAXIN to Sinopharm are and will be denominated in RMB going forward. Our China ZADAXIN sales revenues have been (under the prior adjustment mechanism which operated on a lag basis), currently are, and will be in the future (as invoiced directly in RMB) subject to exchange rate risk.

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We anticipate that ZADAXIN revenues in 2017 will be higher than 2016, although our revenues are subject to exchange rate fluctuations and provincial adjustments to tender (retail level, government approved) prices which we cannot predict.

Recent g overnmental policy changes in China have eliminated national regulation of the maximum retail drug prices for most drugs effective as of June 1, 2015. Decisions by provincial authorities appear to be emerging as the primary governmental mechanism for price controls. As an example, the Zhejiang provincial authority announced a price limitation for sales of ZADAXIN in the province in April 2015 that became effective in May 2015. Changes in provincial drug prices for ZADAXIN in the provinces could impact our future sales revenues. Recently, Guangdong and Fujian provinces have each announced maximum prices for ZADAXIN that are approximately six and four percent lower, respectively, than the reference (baseline) tender price. We expect these provincial decisions to affect the pricing of ZADAXIN in these provinces with respect to sales made pursuant to contracts dated on and after March 2017 for Guangdong and Fujian, and to affect pricing in other provinces, but the exact timing and consequences to our pricing, especially in other provinces, is uncertain.

In China, pharmaceutical products are imported and distributed through a tiered method of distribution. For our proprietary product ZADAXIN, we manufacture our product using our U.S. and European contract manufacturers, and we generate our product sales revenue through sales of ZADAXIN product to Sinopharm. Sinopharm acts as an importer, and also as the top “tier” of the distribution system (“Tier 1”) in China. Our ZADAXIN sales occur when Sinopharm purchases product from us without any right of return except for replacement of product in the event of damaged product or quality control issues. Passage of title and risk of loss are transferred to Sinopharm at the time of arrival of a shipment at its destination. After the sale, Sinopharm clears products through China import customs, sells directly to large hospitals and holds additional product it has purchased in inventory for sale to the next tier in the distribution system. The second-tier (“Tier 2”) distributors are responsible for the further sale and distribution of the products they purchase from the importer, either through sales of product directly to the retail level (hospitals and pharmacies), or to third-tier (“Tier 3”) local or regional distributors who, in turn, sell products to hospitals and pharmacies.

Promotion services revenue s were   $ 1.2   million and $1.1 million   for the quarters ended June 30 , 2017 and 2016, respectively, an increase of $ 0.1 million, or 3 % .   Promotion services revenu es were $ 2.4 million and $2.3 million for the six month periods ended June 30, 2017 and 2016 , respectively, an increase of $ 0.1 million , or 5 %. The increase s are related mainly to an increase in   Endoxan TM product sales.  

We continue to assess the financial performance of the products we promote and distribute under our agreements and their overall value within our entire portfolio of products. Over time, we anticipate the product mix that we promote will change, which may affect our revenues and profitability in the future. If any of these agreements are determined to no longer be beneficial to us and are allowed to expire, or if third parties will not renegotiate, renew or extend the agreements on terms acceptable to us, our revenues would be adversely affected and our profitability may be adversely or beneficially affected. On the other hand, if we are successful in negotiating better terms, there may be a positive impact on our revenues and profitability.

All of our promotion services revenue and a majority of our product revenues are related to our China segment. Total China revenues were $ 42.6 million and $ 37.3 million, or   96 % and 96 % of sales for the three months ended June 30 , 2017 and 2016, respectively. Rest of the World segment revenues were $ 2.0 million and $ 1.7 million, or 4 % and 4% for the three months ended June 30 , 2017 and 2016, respectively, and related to sales of ZADAXIN product.

Total China revenue s were $ 82.5 million and $72.1 million, or 94 % and 96% of sales for the six months ended June 30, 2017 and 2016, respectively. Rest of the World segment revenues were $ 4.9 million and $ 3.4 million, or 6 % and 4% for the three months ended June 30, 2017 and 2016, respectively, and rela ted to sales of ZADAXIN product .

For the three months ended June 30 , 2017 and 2016, sales to Sinopharm in China accounted for approxi mately 93 % a nd 93 % of our revenues, respectively. For the six months ended June 30, 2017 and 2016, sales to Sinopharm in China accounted for approximately 92 % and 92 % of our revenues, respectively.   Our experience with our largest customer has been good and we anticipate that we will continue to sell a majority of our product to them.

Cost of Product Sales:

The following table summarize s the period over period change in our cost of product sales   (in thousands ) :









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

Three Months Ended

  

 

 

Six Months Ended

  

 



 

June 30,

 

 

 

June 30,

 

 



  

2017

  

2016

  

Change

 

2017

  

2016

  

Change

Cost of product sales

  

$

5,654 

  

$

5,712 

  

-1%

 

$

11,819 

  

$

11,525 

  

3% 

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Cost of product sales was $5.7 million for the three month period ended June 30, 2017, compared to $5.7 million for the corresponding period in 2016, a decrease of $0.1 million, or 1%. ZADAXIN cost of sales decreased $0.2 million for the three month period ended June 30, 2017, compared to the same period of last year, benefiting from lower production costs from increased volumes and larger production lot sizes, partially offset by a $0.1 million increase in DC Bead cost of sales for the three month period ended June 30, 2017, compared to the same period of last year.

Cost of product sales was $11.8 million for the six month period ended June 30, 2017, compared to $11.5 million for the corresponding period in 2016, an increase of $0.3 million, or 3%. Cost of product sales for the six month period ended June 30, 2017, compared to the same period of last year related to oncology products increased by $0.4 million due to combination of a 13% volume increase and from product mix, and increased by $0.1 million related to DC Bead sales due to increa