SciClone Pharmaceuticals, Inc.
SCICLONE PHARMACEUTICALS INC (Form: 10-Q, Received: 11/09/2016 16:35:09)

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 September 30, 2016



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, or a smaller reporting company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.



 

 

 

 

 

 

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

  

Smaller Reporting Company

 

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 November   2 ,   2016 ,   51,053,583 shares of the registrant’s Common Stock, $0.001 par value, were issued and outstanding.



 

 


 

SCICLONE PHARMACEUTICALS , INC.

TABLE OF CONTENTS



 

 

 

 

 

 

 

 

 

  

PAGE NO.

 

PART I.

 

FINANCIAL INFORMATION

  

 

 

 



 

 

Item 1.

 

Financial Statements (Unaudited)

  

 

 

 



 

 



 

Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015  

  

 

  



 

 



 

Condensed Consolidated Statements of Income for the three- and nine - month periods ended September 30, 2016 and  2015  

  

 

  



 

 



 

Condensed Consolidated Sta tements of Comprehensive Income   for the three- and nine - month periods ended September 30, 2016 and 2015

  

 

  



 

 



 

Condensed Consolidated Statements of Cash Flows for the nine -month periods ended September 30, 2016 and 2015  

  

 

  



 

 



 

Notes to Unaudited Condensed Consolidated Financial Statements

  

 

  



 

 

Item 2.

 

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

  

 

21 

  



 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  

 

34 

  



 

 

Item 4.

 

Controls and Procedures

  

 

34 

  



 

 

PART II.

 

OTHER INFORMATION

  

 

 

 



 

 

Item 1.

 

Legal Proceedings

  

 

35 

  



 

 

Item 1A.

 

Risk Factors

  

 

36 

  



 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

  

 

58 

  



 

 

Item 3.

 

Defaults Upon Senior Securities

  

 

58 

  



 

 

Item 4.

 

Mine Safety Disclosures

  

 

58 

  



 

 

Item 5.

 

Other Information

  

 

58 

  



 

 

Item 6.

 

Exhibits

  

 

59 

  



 

 

 Signature

 

 

  

 

60 

  



 

 

 

 

 

 





 

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)







 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

 

2016

 

2015

ASSETS

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

130,113 

 

$

101,403 

Restricted cash in escrow for SEC settlement (Note 9)

 

 

 —

 

 

12,826 

Accounts receivable, net of allowances of $91 and $594 as of September 30, 2016 and December 31, 2015, respectively

 

 

37,749 

 

 

39,363 

Inventories

 

 

13,751 

 

 

10,976 

Prepaid expenses and other current assets

 

 

2,529 

 

 

3,654 

Deferred tax assets

 

 

94 

 

 

299 

Total current assets

 

 

184,236 

 

 

168,521 

Property and equipment, net

 

 

1,826 

 

 

2,651 

Investments in third party (Note 10)

 

 

2,718 

 

 

 —

Goodwill

 

 

32,101 

 

 

32,979 

Other assets

 

 

12,480 

 

 

12,468 

Total assets

 

$

233,361 

 

$

216,619 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

4,736 

 

$

4,495 

Accrued and other current liabilities

 

 

19,882 

 

 

32,151 

Deferred revenue

 

 

 —

 

 

174 

Total current liabilities

 

 

24,618 

 

 

36,820 

Other long-term liabilities

 

 

78 

 

 

87 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

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; 50,872,875 and 49,533,835 shares issued and outstanding as of September 30, 2016 and December 31, 2015, respectively

 

 

51 

 

 

50 

Additional paid-in capital

 

 

301,433 

 

 

296,086 

Accumulated other comprehensive income

 

 

1,357 

 

 

2,070 

Accumulated deficit

 

 

(94,176)

 

 

(118,494)

Total stockholders’ equity

 

 

208,665 

 

 

179,712 

Total liabilities and stockholders’ equity

 

$

233,361 

 

$

216,619 



 

 

 

 

 

 



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

 

Nine Months Ended



 

September 30,

 

September 30,



 

2016

 

2015

 

2016

 

2015

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Product sales, net

 

$

39,457 

 

$

41,986 

 

$

112,646 

 

$

112,356 

Promotion services

 

 

1,087 

 

 

894 

 

 

3,388 

 

 

2,038 

Total net revenues

 

 

40,544 

 

 

42,880 

 

 

116,034 

 

 

114,394 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product sales

 

 

5,585 

 

 

6,853 

 

 

17,110 

 

 

17,131 

Sales and marketing

 

 

13,320 

 

 

15,073 

 

 

40,104 

 

 

39,746 

Research and development

 

 

3,288 

 

 

1,039 

 

 

9,520 

 

 

8,708 

General and administrative

 

 

7,900 

 

 

7,294 

 

 

23,472 

 

 

20,762 

SEC settlement expense

 

 

 —

 

 

26 

 

 

 —

 

 

10,826 

Total operating expenses

 

 

30,093 

 

 

30,285 

 

 

90,206 

 

 

97,173 

Income from operations

 

 

10,451 

 

 

12,595 

 

 

25,828 

 

 

17,221 

Non-operating income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

 

270 

 

 

252 

 

 

792 

 

 

614 

Other income (expense), net

 

 

451 

 

 

(281)

 

 

330 

 

 

(305)

Income before provision for income tax

 

 

11,172 

 

 

12,566 

 

 

26,950 

 

 

17,530 

Provision for income tax

 

 

1,056 

 

 

587 

 

 

2,632 

 

 

611 

Net income

 

$

10,116 

 

$

11,979 

 

$

24,318 

 

$

16,919 



 

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

$

0.20 

 

$

0.24 

 

$

0.49 

 

$

0.34 

Diluted net income per share

 

$

0.19 

 

$

0.23 

 

$

0.46 

 

$

0.32 



 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares used in computing:

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

 

50,379 

 

 

49,869 

 

 

49,957 

 

 

49,920 

Diluted net income per share

 

 

52,595 

 

 

52,126 

 

 

52,482 

 

 

52,344 



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

 

Nine Months Ended



 

September 30,

 

September 30,



 

2016

 

2015

 

2016

 

2015

Net income

 

$

10,116 

 

$

11,979 

 

$

24,318 

 

$

16,919 

Other comprehensive loss, net of income tax

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

 

(123)

 

 

(661)

 

 

(713)

 

 

(618)

Total other comprehensive loss

 

 

(123)

 

 

(661)

 

 

(713)

 

 

(618)

Total comprehensive income

 

$

9,993 

 

$

11,318 

 

$

23,605 

 

$

16,301 



 

 

 

 

 

 

 

 

 

 

 

 



See accompanying notes to unaudited condensed consolidated financial statements.

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Table of Contents

 

SCICLONE PHARMACEUTICALS , INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)  





 

 

 

 

 

 



 

Nine Months Ended



 

September 30,

 

 

2016

 

2015

Operating activities:

 

 

 

 

 

 

Net income

 

$

24,318 

 

$

16,919 

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

 

 

 

 

 

 

Non-cash expense related to stock-based compensation

 

 

4,576 

 

 

3,437 

Provision for doubtful accounts

 

 

 —

 

 

541 

Provision for expiring inventory

 

 

34 

 

 

 —

Depreciation and amortization

 

 

737 

 

 

802 

Loss on disposal of fixed assets

 

 

 

 

Deferred income taxes

 

 

199 

 

 

12 

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable, net

 

 

1,572 

 

 

(526)

Inventories

 

 

641 

 

 

1,215 

Prepaid expenses and other assets

 

 

686 

 

 

692 

Accounts payable

 

 

(2,470)

 

 

(4,076)

Accrued and other current liabilities

 

 

845 

 

 

11,822 

Deferred revenue

 

 

(174)

 

 

(394)

Other long-term liabilities

 

 

(8)

 

 

(80)

Net cash provided by operating activities

 

 

30,957 

 

 

30,366 

Investing activities:

 

 

 

 

 

 

Investments in third party (Note 10)

 

 

(2,718)

 

 

 —

Loans to third party (Note 4)

 

 

 —

 

 

(7,250)

Proceeds from the sale of short-term investments

 

 

 —

 

 

75 

Purchases of property and equipment

 

 

(141)

 

 

(1,152)

Net cash used in investing activities

 

 

(2,859)

 

 

(8,327)

Financing activities:

 

 

 

 

 

 

Repurchase of common stock including commissions

 

 

 —

 

 

(12,811)

Proceeds related to issuances of common stock, net

 

 

610 

 

 

3,696 

Net cash provided by (used in) financing activities

 

 

610 

 

 

(9,115)

Effect of exchange rate changes on cash and cash equivalents

 

 

 

 

72 

Net increase in cash and cash equivalents

 

 

28,710 

 

 

12,996 

Cash and cash equivalents, beginning of period 

 

 

101,403 

 

 

86,228 

Cash and cash equivalents, end of period

 

$

130,113 

 

$

99,224 



 

 

 

 

 

 

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 generally accepted accounting principles in the United States (“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, 2015 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 sheet data as of December 31, 2015 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 judgments, assumptions and estimates that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ significantly 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 US 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 contributed 9 2 % and 98 % of the Company’s total net revenue for the three-month periods ended September 30, 2016 and 2015, respectively, which revenues related to the Company’s China segment. Sinopharm contributed 92% of the Company’s total net revenue for both the nine -month periods ended September 30, 2016 and 2015, which revenues related to

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the Company’s China segment. There were no other customers that exceeded 10% of the Company’s total net revenue in the periods presented.

Total ZADAXIN p roduct sales were   $3 7 . 8 million or 9 3 % of total net revenues, and were $39 . 2 million or 91 % of total net revenues , for the three months ended September 30, 2016 and 2015, respectively . Total ZADAXIN p roduct sales were $10 7 . 9 million or 93 % of total net revenues, and were   $105 . 9 million or 9 3 % of total net revenues , for the nine months ended September 30, 2016 and 2015, respectively. As of September 30, 2016, approximately $ 3 4 . 8 million, or 92 % , 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 were denominated in US dollars through June 30, 2016 . However, the established importer price was adjusted quarterly based upon exchange rate fluctuations between the US dollar and Chinese Yuan Renminbi (“RMB”) . Effective July 1, 2016, the Company’s sales of ZADAXIN to Sinopharm are and will 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 and months, the RMB has experienced de valuation. Such devaluation negatively affect s the US dollar value of revenues while it positively affects the US 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 December 31, 2015, the Company had a receivable reserve of $0.5 million related to accounts receivable from one customer that was more than one year past due. During 2014, the Company’s subsidiary, SciClone Pharmaceuticals International China Holding Ltd (“SPIL China”) executed an agreement with this customer providing for settlement of the receivable balance, which at the time was $1.9 million, of which $1.0 million was paid in 2014. SPIL China collected $0.4 million under this agreement in May 2015 and this gain on recovery was recorded as a $0.4 million reduction to general and administr ative expense for the   nine -month period ended September 30, 2015. In March 2016, SPIL China collected the remaining $0.5 million from this customer and this gain on recovery was recorded as a reduction to general and administrative expense for the first quarter of 2016. The Company recognized $0.5 million of bad debt expense in general and administrative expense during the first quarter of 2015 related to past due receivables from another customer, due to uncertainty regarding the collectability of the customer’s outstanding receivable balance. The Company wrote-off the $0.5 million of past due accounts receivable from this customer during the fourth quarter of 2015 as uncollectible. As of September 30, 2016, the Company had a receivable reserve of $0.1 million.

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

8


 

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.

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 mechanism in the new contractual arrangement whereby the customer is invoiced at a lower base price relative to that prevailing in the previous agreement. The lower base price (as well as estimated price compensation payable due 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 upon arrival at destination . To date, there are no situations where a provincial tender price is less than the reference (baseline) tender price. The distributor 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 such amount is recognized as revenue after the amo unt has been agreed with the distributor. It is expected that the price compensation due to the Company related to sales in a quarter under the price adjustment mechanism for provinces with tender prices above the ref erence (baseline) tender price will be recognized on a rolling two-to-three 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 which 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 September 30, 2016 and December 31, 2015, the Company’s revenue reserves were   $0. 1 million.

Investments

As of September 30, 2016, the Company’s investment   portfolio included an available-for-sale investment in the common stock of a third party (Note 10) categorized within Level 2 of the fair value hierarchy. This investment security was acquired in early September 2016 . The Company records unrealized gains or losses on available-for-sale investments in other comprehensive income (loss) . Realized gains and losses and declines in value judged to be other-than temporary on available-for-sale investments are included in earnings.

Available-for sale investments are evaluated for impairment each reporting period. An investment is considered impaired if the fair value of the investment is less than its cost. If after consideration of all available evidence to evaluate the realizable value of its investment, impairment is determined to be other-than-temporary, then an impairment loss is recognized in the condensed consolidated statement of operations.

9


 

Inventories

Inventories consist of raw materials, work in progress and finished products. Inventories are valued at the lower of cost or market (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 identify excess and obsolete items, including pharmaceutical products approaching their expiration dates. 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. For the three- and nine - month periods ended September 30, 2016 , the Company recorded inventory write-downs to cost of product sales of approximately $0 and $34,000 , respectively, related to ZADAXIN inventory expected to expire.   For the three- and nine -month periods ended September 30, 2015, the Company recorded no write-downs related to inventory.  

Loans Receivable

Loans receivable are due from a single third party (see Note 4). Loans are initially recorded, and continue to be carried, at unpaid principal balances under “other assets” on the unaudited condensed consolidated balance sheet. 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.

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 the due date. As of September 30, 2016 and December 31, 2015, 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 t he basic and diluted net income   per share computations (in thousands, except per share amounts):  



 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Nine Months Ended



 

September 30,

 

September 30,



 

2016

 

2015

 

2016

 

2015

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,116 

 

$

11,979 

 

$

24,318 

 

$

16,919 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

50,379 

 

 

49,869 

 

 

49,957 

 

 

49,920 

Effect of dilutive securities

 

 

2,216 

 

 

2,257 

 

 

2,525 

 

 

2,424 

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

 

 

52,595 

 

 

52,126 

 

 

52,482 

 

 

52,344 

Basic net income per share

 

$

0.20 

 

$

0.24 

 

$

0.49 

 

$

0.34 

Diluted net income per share

 

$

0.19 

 

$

0.23 

 

$

0.46 

 

$

0.32 



10


 

For the three months ended September 30, 2016 and 2015 , outstanding stock options and awards for 2,394,941   and 1,514,534   shares 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 September 30, 2016 and 2015 , outstanding stock options and awards for 275,0 00   and 312,500   shares , respectively, subject to performance conditions were excluded from the calculation of diluted net income per share because the performance criteria had not been met.

For the nine months ended September 30, 2016 and 2015, outstanding stock options and awards for 2,151,751 and 1,043 , 815 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 nine months ended September 30, 2016 and 2015, outstanding stock options and awards for 275 ,0 00 and 325,137 shares, respectively, subject to performance conditions were excluded from the calculation of diluted net income per share because the performance criteria had not been met.

Error Corrections

The Company revised its condensed consolidated statement of income for the nine   months ended September 30, 2015 by reducing general and administrative expense and increasing sales and marketing expense by $0. 7 million for costs incurred related to marketing events.

The Company provided $1. 3 million of additional income tax expense, and recorded a corresponding accrual in accrued and other current liabilities, during the   nine months ended September 30, 2016 to correct an error. The error corrected reflected the recognition of a previously unrecognized liability for an uncertain tax position related to the potential nondeductibility, under the People’s Republic of China (“ 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 $0.4 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 projected results for full year 2016 and concluded the impact is not expected to be material to the projected annual results. Accordingly, the total adjustment was recorded out-of-period in the first nine months of 2016. Management also concluded that the relevant amounts were not material to current liabilities or stockholders’ equity in any prior period or the current period.    

New Accounting Standards Updates

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, with early application permitted provided that the effective date is not earlier than the original effective date. The Company is in the process of determining what impact, if any, the adoption of ASU 2014-09 will have on its financial statements and related disclosures. The standard permits the use of either the full retrospective or modified retrospective transition method. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

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

11


 

are effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted as of the beginning of an interim or annual period. Additionally, the new guidance may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company has not yet selected an adoption method. The impact of adopting this guidance is not expected to be material to the consolidated financial statements given the Company’s deferred tax amounts.

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 is evaluating the impact of adoption of this update on its consolidated financial statements and related disclosures.

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 te rm 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 appli cation permitted. The Company is evaluating the impact of the adoption of this update on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued 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. The Company currently plans to implement this ASU as required in the first quarter of calendar 2017. The Company does not expect that the adoption will have a material impact on its consolidated financial statements.  

In June 2016, the FASB issued ASU 2016-13, “ Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Statements. ” 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 Payment s (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 prospectively. As the   likelihood of the Company experiencing one or more of the eight

12


 

particular specified transactions is low , ASU 2016-15 is not expected to have a material impact on the Company's consolidated financial statements .



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 investments ) measured at fair value on a recurring basis ( in thousands ):





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

Fair Value Measurements as of September 30, 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)

 

September 30, 2016

Money market funds

 

$

19,693 

 

$

 —

 

$

 —

 

$

19,693 

Common stock investments in third party (Note 10)

 

 

 —

 

 

2,718 

 

 

 —

 

 

2,718 

Total

 

$

19,693 

 

$

2,718 

 

$

 —

 

$

22,411 







 

 

 

 

 

 

 

 

 

 

 

 



 

Fair Value Measurements as of December 31, 2015 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, 2015

Money market funds

 

$

19,678 

 

$

 —

 

$

 —

 

$

19,678 

Total

 

$

19,678 

 

$

 —

 

$

 —

 

$

19,678 













13


 

Note 3 —   Inventories

Inventories   consisted of the following (in thousands) :



 

 

 

 

 

 



 

 

 

 

 

 



 

September 30,

 

December 31,



 

2016

 

2015

Raw materials

 

$

4,367 

 

$

3,871 

Work in progress

 

 

258 

 

 

535 

Finished goods

 

 

9,126 

 

 

6,570 



 

$

13,751 

 

$

10,976 



Included in the Company’s inventory a s of September 30, 2016 and December 31, 2015   was   $3 . 0 million and $ 3.3 million , respectively,   in inventory held at distributors related t o   non-ZADAXIN products .

Note 4 —   Loans Receivable

As part of the Company’s May 2013 license and supply agreement with Zensun (Shanghai) Science & Technology Co. Ltd (“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 Republ ic of China, Hong Kong and Macao ) is more fully described in the Company’s quarterly report on Form 10-Q for the second quarter of 2013.

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$ 232 ,000 as of September 30, 2016 ) 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 US-dollar denominated borrowings up to $11.75 million. As of September 30, 2016, borrowings totaling $11.7 5 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 mature on September 26, 2017, with an option (granted at loan origination) electable by the borrower to extend for two additional years provided certain conditions are met. As of September 30, 2016, the borrower had notified the Company of its intent to exercise its option to extend the borrowings for two additional years. All 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,

14


 

concluded there were no indications of loan impai rment as of   September 30, 2016 or December 31, 2015; accordingly, there is no allowance for losses.

The two loans are included in “other assets” on the Company’s unaudited condensed consolidated balance sheet as of September 30, 2016 and December 31, 2015 . Interest income on the loans amounted to $0. 2 million for both the three months ended September 30, 2016   and 2015. Interest income on the loans amounted to $0. 7 million and $0. 5 million for the nine months ended September 30, 2016 and 2015, respectively, and is included in interest and investment income in the unaudited condensed consolidated statement s of income .

Note 5 —   Goodwill

The follow ing table represents the change in goodwill for the nine months ended September 30, 2016  ( in thousands ):



 

 

Balance as of December 31, 2015

$

32,979 

Translation adjustments

 

(878)

Balance as of September 30, 2016

$

32,101 



 

 







Note 6 Accrued and Other Current Liabilities

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



 

 

 

 

 

 



 

 

 

 

 

 



 

September 30,

 

December 31,



 

2016

 

2015

Accrued SEC settlement loss (Note 9)

 

$

 —

 

$

12,826 

Accrued sales and marketing expenses

 

 

7,300 

 

 

8,511 

Accrued taxes, tax reserves and interest

 

 

5,772 

 

 

4,323 

Accrued compensation and benefits

 

 

3,881 

 

 

4,341 

Accrued professional fees

 

 

1,241 

 

 

1,130 

Accrued manufacturing costs

 

 

1,173 

 

 

444 

Other

 

 

515 

 

 

576 



 

$

19,882 

 

$

32,151 









Note 7 — Accumulated Other Comprehensive Income (Loss)

Changes in the composition of accumulated other comprehensive income (loss) f or the three and nine   months ended September 30, 2016 and 2015 are as follows ( in thousands ):





 

 

 

Balances as of July 1, 2016

 

$

1,480 

Other comprehensive loss related to foreign currency translation

 

 

(123)

Balances as of September 30, 2016

 

$

1,357 







 

 

 

Balances as of July 1, 2015

 

$

3,307 

Other comprehensive loss related to foreign currency translation

 

 

(661)

Balances as of September 30, 2015

 

$

2,646 





 

 

 

Balances as of January 1, 2016

 

$

2,070 

Other comprehensive loss related to foreign currency translation

 

 

(713)

Balances as of September 30, 2016

 

$

1,357 



15


 





 

 

 

Balances as of January 1, 2015

 

$

3,264 

Other comprehensive loss related to foreign currency translation

 

 

(618)

Balances as of September 30, 2015

 

$

2,646 











Note 8 — Stockholders’ Equity

Stock-based Compensation

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



 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Nine Months Ended



 

September 30,

 

September 30,



 

2016

 

2015

 

2016

 

2015

Sales and marketing

 

$

286 

 

$

217 

 

$

728 

 

$

685 

Research and development

 

 

92 

 

 

65 

 

 

200 

 

 

159 

General and administrative

 

 

1,729 

 

 

1,079 

 

 

3,648 

 

 

2,593 



 

$

2,107 

 

$

1,361 

 

$

4,576 

 

$

3,437 

Stock Options

During the nine months ended September 30, 2016, the Company granted options to purchase a total of 1,390,000 shares of common stock and options to purchase 1,630,359 shares of common stock were exercised. As of September 30, 2016, there was approximately $ 7 . 4 million of unrecognized compensation expense, net of forfeitures, related to non-vested stock options, which is expected to be recognized over a weighted-average remaining period of approximately 2. 5 0 years.

Restricted Stock Units (RSUs)

During the nine months ended September 30, 2016, 315 ,000 RSUs were granted at a grant date fair value per share of $ 10 . 01 and 150,500 RSUs vested. As of September 30, 2016, there was approximately $ 4 . 3 million of unrecognized compensation cost, net of forfeitures, related to non-vested RSUs, which is expected to be recognized over a weighted-average remaining period of approximately 1.48 years.  

Repurchase of Common Stock

The Company repurchased and retired 1,526,306 shares at a cost of $12.8 million during the nine -month period ended September 30, 2015 under its share repurchase program that expired December 31, 2015.



Note 9  —   Commitments and Contingencies

Legal Matters

The Company is a party to various legal proceedings and was subject to government investigations, as noted in this section below. All legal proceedings and any government investigations are subject to inherent uncertainties, unfavorable rulings or other adverse events which could occur. Unfavorable outcomes could include substantial monetary damages or awards, injunctions or other remedies, and if any of these were to occur, the possibility exists for a material adverse impact on the Company’s business, results of operations, financial position, and overall trends. The Company might also conclude that settling one or more such matters is in the best interests of its stockholders and its business, and any such settlement could include substantial payments.

As previously disclosed, since 2010 the SEC and the US Department of Justice (“DOJ”) had each been conducting formal investigations of the Company regarding a range of matters, including the possibility of violations of the Foreign Corrupt Practices Act (“FCPA”), primarily related to certain historical sales and marketing activities with respect to the Company’s

16


 

China operations. In response to these matters, the Company’s Board appointed a Special Committee of independent directors (the “Special Committee”) to oversee its response to the government inquiry. Based on an initial review, the Special Committee decided to undertake an independent investigation as to matters reflected in and arising from the SEC and DOJ investigations in order to evaluate whether any violation of the FCPA or other laws occurred.

The Company previously recorded a charge to operating expenses in the fourth quarter of 2013 in the amount of $ 2.0   million for the accrual of an estimated loss associated with the SEC and DOJ investigations based on the available information at the time. In the second quarter of 2015, the Company recorded an additional charge to operating expenses of $10.8 million based on an agreement in principle reached with the SEC which had not yet been finalized at that time , bringing the accrued liability to $12.8 million.

On October 7, 2015, the Company deposited $12.8 million in an interest-bearing escrow account that it established related to the agreement in principle regarding a proposed settlement of FCPA-related matters with the staff of the SEC, creating a cash restriction at the time of deposit. On February 4, 2016, the Company announced that it entered into a settlement agreement with the SEC fully resolving the SEC’s investigation into possible violations of the FCPA. Under the terms of the settlement agreement, in February 2016 the Company paid to the SEC a total of $12.8 million which was released from its escrow account, including disgorgement, pre-judgment interest and a penalty as final settlement. This payment was in line with the charges the Company previously recorded and disclosed as summarized above. As part of the agreement the Company neither admitted nor denied engagement in any wrongdoing and the Company agreed to give status reports to the SEC for the next three years on its continued remediation and implementation of anti-corruption compliance measures. The DOJ has also completed its related investigation and has declined to pursue any action.

NovaMed Pharmaceuticals (Shanghai) Co. Ltd. (“NovaMed Shanghai”) 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. NovaMed Shanghai filed an application for binding arbitration with the China International Economic and Trade Arbitration Commission (“CIETAC”) on July 26, 2012. On April 2, 2014, CIETAC issued the final Award of the Arbitral Tribunal. The Arbitral Tribunal found that MEDA did have a right to terminate the agreement upon a change of control, but that MEDA must make reasonable reimbursement to NovaMed Shanghai before any product rights are returned to MEDA. The amount that must be paid includes $333,333   as “unjust enrichment” plus an amount for reasonable compensation for such services provided by NovaMed Shanghai to MEDA. The amount of such payment for services was not determined by the Arbitral Tribunal, but was left to be determined by NovaMed Shanghai . On April 30, 2014, NovaMed Shanghai informed MEDA that its determination of reasonable compensation for its services was   $ 3,314,629 , including the $333,333 for unjust enrichment. MEDA made a counter offer and the parties were attempting to resolve the matter without an additional arbitration proceeding. In December 2014, NovaMed Shanghai filed a “Request for Second Arbitration” with CIETAC in order to enforce its right to compensation. The arbitration case is pending with CIETAC .   On April 20, 2016, the Second Arbitral Tribunal ordered the bifurcation of the proceedings. The first stage of the proceedings will deal with the question whether NovaMed Shanghai in principle has claims against MEDA. A first oral hearing took place on July 6 and 7, 2016. The parties were originally invited to comment on the issues raised at the first hearing until October 14, 2016. Due to ongoing settlement negotiations between the parties this deadline has been extended to December 23, 2016. If one party feels the need to then respond to the other party's submission, the Second Arbitral Tribunal will at its discretion grant such opportunity to file an additional submission until February 6, 2017 .   The parties are further expected to file cost submissions by February 13, 2017. In parallel, the parties are in settlement discussions. The date for the next hearing has not yet been scheduled. The amount of any final payment to NovaMed Shanghai remains uncertain, and as such the Company has not recognized it as a gain contingency .

17


 

Purchase Obligations

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 September 30, 2016 , the Company did not have any material unmet purchase obligations.

Note 10 — Investments in Third Party

On September 9, 2016, the Company and Soligenix, Inc. (trading under ticker “SNGX D ” on the OTCQB over-the-counter market) 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, including Hong Kong and Macau, as well as 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 candidat e 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 c ommon 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 cost of $2.7 million representing public ly available quoted prices. As of September 30, 2016, the fair value of the Soligenix common stock investment was $2.7 million and unrealized gains (losses) on the investment were zero. The Company is holding the Soligenix shares in  t h e context of a business relationship, and as such has class if ied them as available- f or -sale. The common stock inves t ment will be adjusted to f a i r value at each reporting date with unrealized gains (losses) reported as a componen t of other comprehensive income (loss). The residual cash consideration of $0.3 million related to the expanded territorial rights was recorded as research and development expense for the three - and nine - month periods ended September 30, 2016 .

Note 1 1 — In-License Costs

For the three- and nine -month periods ended September 30, 2016, the Company recognized $0.3 million and $2. 3 million of research and development (“R&D”) expenses for upfront and milestone payments related to in-license agreement s . For the three-and nine -month periods ended September 30, 2015, the Company recognized $0 and $5.5 million , respectively, in R&D expenses related to upfront and milestone payments for its in-license agreements, primarily with Theravance Biopharma, Inc.



Note 1 2 — Income Taxes

The provision for income taxes primarily relates to taxable income of the Company ’s China operations. The provision for income tax was $ 1 . 1 million and $0. 6 million for the three-month periods ended September   30, 2016 and 2015, respectively. The lower tax for the three-month period ended September 30, 2015 primarily related to the restructuring of the Company’s China business. The provision for income tax was $2 .6 mi llion and $0.6 million for the nine month periods ended September 30, 2016 and 2015, respectively. For the nine -month period ended September 30, 2016, the Company’s tax provision included

18


 

$1.3 million of additional tax expense representing the correction of an error related to a previously unrecognized liability for an uncertain tax position in China (refer also to Note 1, “ Error Corrections” ) . In addition, the tax provision for the nine -month period ended September 30, 2015 was lower, compared to the nine -month period ended September 30, 2016, due to lower tax related to restructuring the Company’s China business. The Company’s statutory tax rate in China was 25% in 2016 and 2015.

T he Company has concluded that its offshore undistributed accumulated earnings as of December 31, 2015 were indefinitely reinvested, and has therefore provided no taxes thereon . T he Company concluded that a portion of its earnings expected to be generated by foreign subsidiaries in 2016 will be repatriated to the parent company in order to address the parent company’s liquidity needs. A dividend distribution was already made to the parent company in early 2016 and further distrib utions may be made. The actual r epatr i ation year-to - date a nd any further anticipated   repatriations , however, are not expected to result in any additional US federal or state tax liability for 2016 as ongoing tax-deductible corporate expenses already incurred and expected to be incurred by the parent company more than offset the amount of the taxable income represented by the dividend distribution s . These actual amounts and expectations have been reflected in the Company’s estimated annual effective tax rate for 2016.

Note 1 3 — 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.

The 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 US and Hong Kong.

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 nine -month periods ended September 30, 2016 and 2015 is as follows ( in thousands ):



19


 



 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Nine Months Ended



 

September 30,

 

September 30,



 

2016

 

2015

 

2016

 

2015

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

38,315 

 

$

40,676 

 

$

110,442 

 

$

109,388 

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

 

 

2,229 

 

 

2,204 

 

 

5,592 

 

 

5,006 

Total net revenues

 

$

40,544 

 

$

42,880 

 

$

116,034 

 

$

114,394 

Income (loss) from operations:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

14,500 

 

$

14,649 

 

$

41,154 

 

$

34,650 

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

 

 

(4,049)

 

 

(2,054)

 

 

(15,326)

 

 

(17,429)

Total income from operations

 

$

10,451 

 

$

12,595 

 

$

25,828 

 

$

17,221 

Non-operating income (expense), net:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

719 

 

$

(44)

 

$

1,113 

 

$

288 

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

 

 

 

 

15 

 

 

 

 

21 

Total non-operating income (expense), net

 

$

721 

 

$

(29)

 

$

1,122 

 

$

309 

Income (loss) before provision for income tax:

 

 

 

 

 

 

 

 

 

 

 

 

China

 

$

15,219 

 

$

14,605 

 

$

42,267 

 

$

34,938 

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

 

 

(4,047)

 

 

(2,039)

 

 

(15,317)

 

 

(17,408)

Total income before provision for income tax

 

$

11,172 

 

$

12,566 

 

$

26,950 

 

$

17,530 



Long-lived assets as of September 30, 2016 and December 31, 2015 by operating segment are as follows ( in thousands ):



 

 

 

 

 

 



 

September 30,

 

December 31,



 

2016

 

2015



 

 

 

 

 

 

China

 

$

47,755 

 

$

46,315 

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

 

 

1,370 

 

 

1,783 



 

$

49,125 

 

$

48,098 















20


 

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;

·

government regulatory action affecting our Company or our drug products or our competitors' drug products in China, the US 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 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 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 scope of our sales and marketing; 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 resolution of the SEC and 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;

·

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

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·

other factors discussed in this Report under Part I, Item 2 “Management ’s Discussion and Analysis of Financial Condition 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. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Overview  

SciClone Pharmaceuticals, Inc. (NASDAQ: SCLN) is a United States (“US”)-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 and we are focused on establishing profitability in all of these collaborations. We believe our sales and marketing strengths position us to benefit from the long-term expansion of the pharmaceutical market in China. According to Globe Newswire, the Chinese pharmaceutical market currently ranks second among the global pharmaceutical markets, and had an estimated worth of $105 billion in 2014. It is forecasted to increase significantly to $200 billion by 2020. 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.

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 US 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, for which we initiated sales and recorded product revenue beginning in the third quarter of 2015, and products from Pfizer International Trading (Shanghai) Ltd. (“Pfizer”). Through June 30, 2015, our product sales revenues also included Aggrastat ® , an intervention cardiology product launched in China in 2009, in-licensed from Cardiome Pharma Corp (“Cardiome”). In August 2015, we and Cardiome mutually agreed to end our collaboration for Aggrastat, thereby terminating our exclusive distribution rights in China, and returning all rights to the product to Cardiome. We rec orded Aggrastat revenues of $1.8 million for the nine months ended September 30, 2015 ,   none thereafter, and we do not expect to generate any further Aggrastat revenues. We do not anticipate that the termination of this agreement will adversely affect our profitability.

ZADAXIN has the highest margins in our portfolio as it is a premium product sold exclusively by SciClone. In addition, we anticipate that new marketed products, when and if introduced, can increase the future revenues and profitability of our pharmaceutical business in China over the coming years. Our “promotion services revenues” result from fees we receive for exclusively promoting 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. Over time, as additional proprietary or in-licensed products come to the market, we aim to shift our product mix towards those products providing higher margins for us.

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

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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 on September 26, 2016, we announced the first patient has been treated in the investigat or- initiated clinical trial in 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, and we believe our oncology sales team and academic marketing liaisons have established high quality relationships with medical professionals and institutions that specialize in cancer treatment, which we believe will be a valuable asset as we continue commercial sales of DC Bead. BioCompatibles UK Ltd. (“BTG”) and SciClone previously entered into an agreement granting SciClone exclusive licensing and distribution rights to DC Bead in China. Under the agreement, we are purchasing DC Bead product from BTG.

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

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 are pursuing additional agreements to generate additional revenue. 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. Our objective is to in-license products that provide us with higher margins, augmenting our product sales revenue and profitability, and we continue to explore opportunities to optimize our promotion services revenues.

On September 26, 2016, we also 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 portf olio and drive long-term growth. We obtained , in 2015, exclusive development and commercialization rights to PT-112 from Phosplatin Therapeutics for Greater China (mainland China, Hong Kong, and Macau) and Vietnam, along with option rights in South Korea and Taiwan.

On September 12, 2016, we and S oligenix, 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 pat i ents with head and neck cancer. The licensing agreement includes the People’s Republic of China, including Hong Kong and Macau, as well as Taiwan, South Korea and Vietnam (the “Territory”) . This exclusive agreement builds on an existing collaboration, in w hich we provided our comp l ete oral mucositis cli ni c al and regulatory data library to Soligenix in exchange for certain, previously un d is cl osed, commercialization righ t s to SGX942 in the Greater China market. The Phase 2 preliminary 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 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.

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In May 2015, Theravance Biopharma, Inc. (“Theravance Biopharma”) granted SciClone exclusive development and commercialization rights to VIBATIV ®   (telavancin) in China, as well as the Hong Kong SAR, the Macao SAR, 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.

In December 2014, we entered into a strategic partnership with The Medicines Company for two cardiovascular products in China. The partnership includes an agreement granting us a license and the exclusive rights in China to promote two 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 for which a Phase 3 registration trial was completed in China and is currently under review by the China Food and Drug Administration for marketing approval, 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 which a clinical trial application (CTA) for China was filed in 2013. We received CTA approval from the China Food and Drug Administration (“CFDA”) in early 2016 and are preparing a clinical study .   As 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 will now be working together with Chiesi and The Medicines Company to progress the Cleviprex clinical study going forward. Under the terms of the agreement, which apply to Chiesi for Cleviprex, we 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 have also agreed to participate in the China registration process for both products. Financial terms of the agreement, in addition to net sales royalties payable to The Medicines Company, include the following additional payments to The Medicines Company and 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.  

O u r license agreement with Taiwan Liposome Company (“TLC”) grants us a license and the exclusive rights in China to promote, market, distribute and sell ProFlow ®   for the treatment of peripheral arterial disease (“PAD”) and other indications. In November 2014, TLC was notified by the CFDA that ProFlow did not receive clinical trial approval .   TLC appealed the decision and the CFDA has not rendered a final decision .  

In May 2013, we entered into a framework agreement with Zensun (Shanghai) Science & Technology Co., Ltd. (“Zensun”) for the exclusive promotion, marketing, distribution and sale of Neucardin TM 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 a New Drug Application (“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 September 30, 2016 (refer to Note 4 to the unaudited condensed consolidated financial statements appearing under Part I, Item 1 for further information regarding the Zensun loans).

Recent 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 to our distributor in our sales channel; accordingly, the impact of the price reduction for the year ended December 31, 2015 was $2.8 million. The impact of the 2015 tender price reduction in Zhejiang province does not require providing for estimated price compensation payable under our new contractual arrangement with Sinopharm, which took effect January 1, 2016, as the lower tender price is reflected in a

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lower base invoice price to our customer under the new contractual arrangement. We anticipate that provincial pricing decisions will continue to be a significant factor in the China pharmaceutical market for the foreseeable future. The impact of such decisions on our future results is unpredictable, but we expect that pricing pressures on revenue in 2016 will be offset at least in significant part 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 addition, our new contractual arrangement with Sinopharm Holding Lingyun Biopharmaceutical (Shanghai) Co. Ltd (Sinopharm), our China distributor for ZADAXIN, which commenced January 1, 2016 is resulting in the later recognition (relative to practices prevailing through December 31, 2015 under the expired prior contractual arrangement) of a portion of our revenue invoiced to Sinopharm in situations where the provincial tender price (ultimate retail end price approved by provincial authorities) is greater relative to a reference (baseline) tender price. This is due to a price adjustment mechanism in the new contractual arrangement whereby the customer is invoiced at a lower base price relative to that prevailing in the previous agreement. The lower base price (as well as estimated price compensation payable due to the distributor for situations where the provincial tender price is lower than the referenced (baseline) tender price) is recorded as revenue at the time the sale is completed upon arrival at destination . Currently, there are no provinces with lower-than-reference tender prices leading to price compensation payable. The distributor is then 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 such amount will be recognized as revenue after the amount has been agreed upon with the distributor. 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, we expect that the price compensation receivable due to us from the distributor for higher tender price provinces for a quarter will be re co gnized on a two-to-three quarter delayed basis relative to the originating sales quarter   going forward.

As previously disclosed, since 2010 the US Securities and Exchange Commission (“SEC”) and the US Department of Justice (“DOJ”) had each been conducting formal investigations of us regarding a range of matters, including the possibility of violations of the Foreign Corrupt Practices Act (“FCPA”). On February 4, 2016, we announced that we entered into a settlement agreement with the SEC fully resolving the SEC’s investigation into possible violations of the FCPA. Under the terms of the settlement agreement, in February 2016 we paid a total of $12.8 million, including disgorgement, pre-judgment interest and a penalty as final settlement which was released from our restricted escrow account which we funded in the fourth quarter of 2015. This payment is in line with the charges we previously recorded and disclosed in our Form 10-Q filed with the SEC on August 10, 2015. As part of the agreement we neither admitted nor denied engagement in any wrongdoing and we agreed to give status reports to the SEC for the next three years on our continued remediation and implementation of anti-corruption compliance measures. The DOJ has also completed its related investigation and has declined to pursue any action (refer to Note 9 to the unaudited condensed consolidated financial statements appearing under Part I, Item 1 and “Legal Proceedings” in Part II, Item 1 for further information regarding the SEC and DOJ investigations).

In early February 2016, we announced that our Board of Directors had initiated a p rocess to identify, examine and co nsider a range of strategic alternatives avai la b l e to us with a view to enhancing stockholder value and had enga g ed Lazard as its financial advisor to assist the Board in evaluating strategic alternatives. In July 2016, we announced tha t ou r Board is no longer continuing active discussions with potential acquirers which were undertaken as part of its str a tegic review proces s and that the Board will contin ue to evaluate additional strategic opportunities while continuing to focus on growing the Company’s business.

We believe our cash and cash equivalents as of September 30, 2016 and ongoing revenue generating business operations will be sufficient to support our current operating plan for at least the next 12 months. Our results may fluctuate from quarter to quarter and we may report losses in the future.

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Results of Operations                               

Revenues:

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



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

Three Months Ended

  

 

 

Nine Months Ended

  

 



 

September 30,

 

 

 

September 30,

 

 



  

2016

  

2015

  

Change

 

2016

  

2015

  

Change

Product sales, net

 

$

39,457 

  

$

41,986 

  

-6%

 

$

112,646 

  

$

112,356 

  

0% 

Promotion services

 

 

1,087 

 

 

894 

 

22% 

 

 

3,388 

 

 

2,038 

 

66% 

Total net revenues

 

$

40,544 

 

$

42,880 

 

-5%

 

$

116,034 

 

$

114,394 

 

1% 



Product sales were $ 39. 5 million for the three-month period ended September 30, 2016 compared to $ 42.0 million for the corresponding period in 2015, a de crease of $ 2. 5 million, or 6 %. ZADAXIN sales were $ 3 7.8 million for the three-month period ended September 30, 2016, compared to $39 . 2 million for the corresponding period of 2015, a de crease of $ 1. 4 million or 3 % , which mainly related to a 12 % increase in volum e sold, offset by a 9 % decrease in selling price related to a decrease in the list price of ZADAXIN in Zhejiang province since May 2015 and related to a lower base invoice price in our new arrangement with Sinopharm that became effective January 1, 2016 discussed below as well as a 6% unfavorable exchange rate impact .   DC Bead product sales were $0 and $1.0 million, respectively, for the three months ended September 30, 2016 and 2015.

Product sales were $ 112. 6 million for the nine -month period ended September 30, 2016 compared to $ 112.4 million for the corresponding period in 2015, an increase of $ 0. 3   million, or 0 %. ZADAXIN sales were $ 10 7 . 9   million for the nine -month period ended September 30, 2016, compared to $ 105.9 million for the corresponding period of 2015, an increase of $2. 0 million or 2 %, which mainly related to a 15 % increase in volume sold, offset partially by a 7 % decrease in selling price related to a decrease in the list price of ZADAXIN in Zhejiang province since May 2015 and related to a lower base invoice price in our new arrangement with Sinopharm that became effective January 1, 2016 discussed below as well as a 6% unfavorable exchange rate impact .   DC Bead product sales were $0 and $1.0 mill ion, respectively, for the nine months ended September 30, 2016 and 2015, respectively. Product sales increased $1.0 million for the nine months ended September 30, 2016, compared to the corresponding period of 2015 , related to our oncology product sales. Aggrastat ® product sales were zero and $ 1.8 million for the nine -month periods ended September 30, 2016 and 2015, respectively, due to the termination of our agreement with Cardiome as discussed below. 

Our new 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 the customer is invoiced at a lower base price relative to that prevailing in the previous agreement. The lower base price (as well as estimated price compensation payable due 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 (arrived at destination). There are presently no provinces with tender prices below the reference (baseline) tender price, and therefore no price compensation payable situations. The distributor is then 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 such amount will be recognized as revenue after the amount has been agreed upon with the distributor. 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 amou nts and timing. For example, the price compensation receivable due to us from the distributor for higher tender price provinces for amount s sold in the first quarter of 2016 was recognized in the third quarter of 2016 in the amount of $0.2 million. W e expect that the price compensation receivable due to us from the distributor for higher tender price provinces for a qua rter will be recognized on a two-to-three   quarte r delayed basis relative to the originating sales quarter going forward.

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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 US dollars through June 30, 2016 . However, the established importer price was adjusted quarterly based upon exchange rate fluctuations between the US 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) and will be in the future (as invoiced directly in RMB) subject to exchange rate risk. In recent months the RMB has experienced devaluation.

We anticipate that ZADAXIN revenues in 2016 will be higher than 2015, although our revenues are subject to exchange rate fluctuations and provincial adjustments to tender (retail level, government approved) prices which we cannot predict.

Recent 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. Changes in provincial drug prices for ZADAXIN in the provinces could impact our future sales revenues.

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 US 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 was $ 1.1 million and $0. 9 million for the quarters ended September 30, 2016 and 2015, respectively, an increase of $ 0.2 million, or 22 %. Promotion services r evenue was $ 3.4 million and $2.0 million for the nine -month period s ended September 30, 2016 and 2015, respectively, an increase of $1.4 million, or 66 %. The increase s related to increased sales of   Endoxan TM   and Holoxan TM   product promoted under our agreements with Baxter.

Our Baxter promotion agreement is for a 5-year term, through December 2017. Our Pfizer product distribution agreement is for a 5-year term, through June 2019. In August 2015, we and Cardiome, from whom we licensed Aggrastat, mutually agreed to end our collaboration for Aggrastat, and we return ed all rights to the product to Cardiome. We recorded Aggrastat revenu es of $1.8 million for the nine months ended September 30, 2015 ,   and none thereafter . We do not expect to generate any further Aggrastat revenues. We do not anticipate that the termination of this agreement will adversely affect our profitability.

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 , related to our China segment. Total China revenues were $38. 3 million and $ 40.7 million , respectively , or 95% of sales , for both   the three months ended September 30,  

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2016 and 2015. Rest of the World segment revenues were $2.2 million , or   5% , for both   the three months ended September 30, 2016 and 2015 ,   and related to sales of ZADAXIN product.  

Total Chin a   revenues were $ 110. 4 million and $109.4 million, or 95% and 96% of sales , respectively, for   the nine months ended September 30, 2016 and 2015 . Rest of the World segment revenues were $ 5.6 million and $5.0 million, or 5% and 4 % ,   for the nine months ended September 30, 2016 and 2015, respectively, and related to sales of ZADAXIN product.

For the three months ended September 30, 2016 and 2015, sales to Sinopharm in China accoun ted for approximately 92 % and 98 % of our revenues, respectively. For both the nine -month periods ended September 30, 2016 and 2015, sales to Sinopharm in China accounted for approximately 92%   of our revenues. 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 s summarize the period over period change s in our cost of product sales (in thousands) :



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

Three Months Ended

  

 

 

Nine Months Ended

  

 



 

September 30,

 

 

 

September 30,

 

 



  

2016

  

2015

  

Change

 

2016

  

2015

  

Change

Cost of product sales

  

$

5,585 

  

$

6,853 

  

-19%

 

$

17,110 

  

$

17,131 

  

0% 

Cost of product sales for the three months ended Septemb er 30, 2016 decreased $1.3 million or 19%, compared to the corresponding period in 2015 mainly related to reduction s in DC Bead , Methotrexate ® and Aggrastat cost of product sales primarily r elated to a reduction in sales of those products .   In addition, cost of product sales of ZADAXIN decreased due to manufacturing overhead volume efficiencies. Cost of product sales was $ 17.1 million for both the nine -month period s ended September 30, 2016 and 2015.  

We expect our ZADAXIN cost of product sales and gross margins to fluctuate from period to period depending on the level of sales and price of our products, the absorption of product-related fixed costs, currency exchange fluctuations, any charges associated with excess or expiring finished product inventory, and the timing of other inventory period costs   such as manufacturing process improvements for the goal of future cost reductions.

Overall, we expect our gross margin percentages in 2016 to be slightly lower than 2015, based on lower selling prices in certain province s , with indications of others to follow, as well as the unfavorable impact of currency exchange fluctuations.

Sales and Marketing (“S&M”) :

The following table s summarize the period over period change s in our S&M expenses (in thousands):





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

Three Months Ended

  

 

 

Nine Months Ended

  

 



 

September 30,

 

 

 

September 30,

 

 



  

2016

  

2015

  

Change

 

2016

  

2015

  

Change

Sales and marketing

  

$

13,320 

  

$

15,073 

  

-12%

 

$

40,104 

  

$

39,746 

  

1% 

S&M expenses for the three months ended September 30, 2016 de creased by $ 1.8 million, or 12 %, compared to the corresponding period in 2015 .   The decrease in S&M expense for the three months ended September 30, 2016, compared to the corresponding period in 2015, primarily related to decreases in sales and marketing events and lower DC Bead-related launch costs. S&M expenses for the nine months ended September 30, 2016 increased by $ 0.4 million, or 1 % , compared to the corresponding period in 2015 , related to growth in our S&M efforts for ZADAXIN.