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SciClone Pharmaceuticals, Inc. (NASDAQ:SCLN)

Q4 2013 Earnings Conference Call

March 12, 2014 08:30 AM ET

Executives

Jane Green - IR

Friedhelm Blobel - President and CEO

Hong Zhao - CEO, China Operations

Wilson Cheung - SVP, Finance and CFO

Analysts

Hamed Khorsand - BWS Financial

Tim Lynch - Stonepine Capital

Yi Chen - Aegis Capital

Operator

Good day, ladies and gentlemen, and welcome to the SciClone Pharmaceuticals 2013 Financial Results Conference Call. My name is Erica, and I will be your operator for today. At this time all participants are in a listen only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions).

I will now turn the conference over to Jane Green, SciClone Pharmaceuticals’ Investor Relations. Please proceed.

Jane Green

Good morning. SciClone would like to thank you for joining the call today. The Company would also like to remind you that today's call is being recorded. Speaking on today's call are Dr. Friedhelm Blobel, President and Chief Executive Officer; Wilson Cheung, Senior Vice President and Chief Financial Officer; and Hong Zhao, Chief Executive Officer, China Operations. It is SciClone's intent that all forward-looking statements, including statements regarding financial guidance and commercial and development activity made during today's call be protected under the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based on current information available and SciClone assumes no obligation to update these statements. To better understand these risk factors, please refer to the documents that SciClone filed with the Securities and Exchange Commission, including Forms 10-Q and 10-K.

I will turn the call over to Friedhelm Blobel.

Friedhelm Blobel

Good morning, and welcome to SciClone's conference call and webcast to discuss fourth quarter and full year financial results for the year ended December 31, 2013; and to provide an outlook for 2014. We are pleased to report that as anticipated our progress in our core business in the second half of 2013 was strong, well outpacing the first half of the year. The major issues that slowed our progress at the end of 2012 and first half of 2013 has been addressed, setting the stage for what we believe will be a year of re-establishing our Company’s growth trajectory.

We believe that our key growth driver for 2014 will continue to be the strong market demand for ZADAXIN in the current indications for which it is approved, as well as potential new indications supported by enhanced and more targeted sales and marketing strategies.

We are pleased to report that ZADAXIN sales were 47% higher in the fourth quarter of 2013, compared to the same period in 2012, reflecting the resolution of the channel inventory problem and strong demand for ZADAXIN in the second half of 2013, which we believe will continue. Analysts continue to note that the margin for thymalfasin remains strong growing at 16% to 17% per year. We believe that ZADAXIN can regain a growth rate potentially approaching that level. In 2014 we believe we are already off to a strong start.

We have noted before that within China there are new markets opening up, not only tier 1, but also tier 2 cities and that demand for healthcare services and products will increasingly expanded to tier 3 cities and even more rural areas. Our key focus for the next couple of years will be on expanding our presence in major cities such as Beijing, that we anticipate that around of 10% is imminent, as well as growing tier 2 cities. The potential for greater penetration into new target hospitals in these geographies is very high. As you will hear from Hong in few minutes, the restructuring of our sales force, which was prompted by the conclusion of the Sanofi agreement, is having the beneficial effect of bringing greater focus and productivity to our sales and marketing execution.

A key growth opportunity is emerging in the hepatitis B market were ZADAXIN is approved for use. The prevalence of HBV in China is still quite high at approximately 7% and the effectiveness of approved antivirals, such as lamivudine is diminishing because of resistance. We have seen increased market uptake as ZADAXIN is increasingly used in combination of approved antiviral therapy and we intend to continue to market production actively in these indications.

Another growth opportunity we notice beginning to take shape for ZADAXIN is in the area of sepsis. Sepsis remains a large growing and underserved market in China. Following the publication last year of the results of the last trial involving more than 350 patients that showed promising results for use of ZADAXIN in sepsis, the lead principal investigator, who is a well-known key opinion leader in the China market, has increased direct communications through the physicians about ZADAXIN’s potential impact and outcomes. We believe that with continued support, this trend can build over time as physicians share their experiences. We plan to continue to work towards including of thymalfasin into treatment gaudiness. In terms of our collaboration. We look forward to continuing our promotion agreements with Baxter and Pfizer and plan to continue to seek additional well-structured in-licensing and product promotion partnerships in order to expand our marketed product portfolio and contribute to our profitability.

We are hopeful that the negotiations with Sanofi concerning promotion fees, we believe are all drugs can soon be concluded. We believe it is unfortunate that after almost a six year mutually beneficial collaboration, Sanofi elected not to renew our promotion agreement and our companies are in a dispute that negatively impacted our fourth quarter and full year revenue and earnings. In our view of the situation, in the fourth quarter Sanofi stopped paying invoices for promotion fees due to us and officially reduced our orders to lower the promotion fees to which we believe we are entitled.

As Wilson will discuss later, assuming for the fourth quarter, the same run rate as in the first three quarters of 2013, we would have earned an additional $9.8 million in revenues during the fourth quarter or approximately $0.18 more on our reported non-GAAP EPS. We remain hopeful that this matter will be resolved between the parties in the near term. Also there is no guarantee that the parties will reach a mutually acceptable resolution and we may need to pursue other legal alternatives.

Our income for challenging 2013 in we which we dealt with internal issues as well as externally with uncertainties in the China pharma market, our outlook for 2014 and for our overall long term growth is positive. We believe that the significant improvements we have made in strengthening the China management team are paying off. We also believe that the enhancements we have made in our business practices and accounting controls and in intensifying our focus on companywide compliance will continue to positively affect our business and build our standing in the China pharma market and in the global investment community.

I'm very proud of the team we have assembled in China and in the U.S., and our ability to continue to attract high quality talent. The most recent member to join our senior management team is Charles Meng, who is our General Counsel and Vice President of Compliance. And he joined us from Novartis where he was General Counsel of the Pharma business in China. I'm confident that we have the right team in place to help us to grow and expand our business and continue to operate effectively and in compliance with our regulatory and legal requirements.

Our Company today is leading and we believe we are deploying our resources cost effectively and operating productively. Hong, Wilson and I recently participated in the 2014 National Sales Meeting in Hongqiao near Shanghai and we are confident that morals within our organization remain strong and positive. We believe that our wider and deeper strategy is the right approach. For the wider strategy, we are expanding our coverage in Tier 2 and Tier 3 cities in high growth provinces such as Shandong, Fujian and others outside of the historically largest five provinces which has been now our Beijing, Shanghai, Guangdong, Jichang and Jiangsu. As part of our deeper strategy, a major opportunity for us lies in forward penetrating the larger hospitals in Tier 1 and especially the Tier 2 cities. We are looking forward as I mentioned to the depending Beijing tender which could further open up a sizable market for our product.

As Hong will discuss, we have successfully implemented a more academically oriented approach to providing medical information to physicians by leveraging the expertise and talent of a more sophisticated, medically trained team of professionals who provide scientific and medical information to physicians more effectively.

Our increased focus on providing academic information and support for a sophisticated staff is modeled on a more western approach and is evidence of the growing sophistication of the China market. Our ability to attract and retain highly trained professional sales people who are medically trained is a key differentiator from generic competitors who compete primarily on price, not quality.

With our strong cash position, we have the resources to pursue strategies, including additional partnering that can expand our portfolio of differentiated high value products and drive our long term revenue and profitability growth. And we plan to continue our share repurchase program, which we strongly believe is about creating strategy for our stockholders.

We continue to see significant growth prospects for China pharma market. China’s massive healthcare reform strategy is an integral part of its evolution from an export based to consumer driven economy. China is trying to achieve a complex balance between increasing access and coverage for healthcare services and products and at the same time controlling the rate of growth in healthcare spending.

Today it is estimated that 280 million to 300 million people have been brought into the healthcare system with estimates that this number will grow to 700 million to 800 million in the next few years as healthcare reform reaches more deeply into secondary and tertiary markets.

That is still only two-thirds of the 1.3 billion people in China who need it. The China pharmaceutical market continues to grow at a rate that far exceeds established western markets. Estimates of that future growth rate for 2014 and beyond are in the 15% to 20% compounded annual growth rate range for the next few years. And as we have noted before, analysts continue to predict that by 2020 China will become the world’s second largest pharmaceutical market, growing to potentially $220 billion to $230 billion by that time.

Along this growth as we all know come challenges in this market. The China government's very public focused on anti-corruption had a significant effect on the overall market in the first quarter of last year. While the market appears to be rebounding, there are indications that we’re seeing a new normal taking shape in the market as some MNCs reevaluate how they want to approach this market.

They have to maintain a presence in order to leverage growth opportunities. But they could also [indiscernible] portfolio in ZADAXIN [ph] product, or reduce their sales presence, all of which could open up interesting opportunities for SciClone either for in-licensing or for promotion deals. We cannot predict at this time what additional market pressures the pharma industry, including us might face. The China government is sometimes opaque in the way it promulgates rule and different provinces are experimenting with pricing and delivery structures that are designed to expand access and control cost.

We see element in the market which could translate into greater pricing pressure for innovate a company down the road. But the positive side in the market that China government continues to support innovative products. Despite these challenges, we believe that our company has significant growth prospects in this market and our experience and supply chain relationships can enable us to deal effectively with changing market dynamics.

We continue to believe that SciClone represents a unique opportunity for investors who want to participate in the growth of the China market and to do so with a company that is headquartered in the U.S., that has an excellent sales and marketing team on the ground in China, had strong performance track record and a strong commitment to constant improvement in its control and compliance practices.

Now I would like to ask Hong to share some of his perspective with us. Hong?

Hong Zhao

Thank you Friedhelm. I would like to address two issues that are high on the SciClone China's team agenda for 2014. First assume that we are almost operating as a focused company that keeps sales and marketing teams with a strong emphasis on continually improved in our compliance practice. And the second that we have the right strategy in place to market our products efficiently and in response to China pharmaceutical market. In terms of our organization, I'm pleased to say that our team has adjusted very well for the restructuring we have implemented.

Our sales and marketing team is still organized into the three business unit. The ZADAXIN business unit as our core business has been expanded towards further penetrating into large hospitals in Tier 1 and Tier 2 and Tier 3 cities. The oncology unit remains stable and focused on the top 300 hundred hospitals. The cardiovascular business unit is nearly established, lean organizing which is focusing on the average, and are preparing for our new created opportunity including [indiscernible] ProFlow, which are anticipating will come to the market in the next two or three years.

The restructuring has in fact enabled us to optimize our self-operation. Our goal is to maintain a size and a structure that can allow us to operate efficiently and effectively to support our current portfolio of the product and accommodate our future growth goals. We have enhanced our training, education, information tools and looking for certification process to enable our sales and marketing professionals to perform at the top of their abilities.

As a result, we believe that promotion team is aligned in the focusing on making 2014 a success growth year for SciClone. A key strategy has been recoupment of the medical sales professionals to augment the other communication with the physicians, particularly as a large sophisticated hospital. Medically trained experts are able to have a high level tier-to-tier tie-up with the physician. They are present particularly when communications about ZADAXIN can significantly enhance physicians’ awareness and understanding of the important differences between our products and the lower quality genetics which will enable us, our sales professionals to operate more efficiently, effectively.

We are pleased with the expert and the professionals, our medical sales team who can further build this ability to our communication with the physicians especially in the cardiovascular area. We continue to emphasize our commitment to the company wide contract. Everyone knows that compliance is a key ingredient to measuring an individual as well as team performance.

It is as important a goal as our revenue and probability. It will understand internally that we have [indiscernible] fulfill to meet our high expectations. In terms of the changing trend in the China [ph] market, we believe we can deal with the changing dynamics as the government continue to both expand access and control the cost.

Pricing and the generics competition continue to be challenging but we believe that the growth opportunity in this market outweighs growth for future. We cannot predict what initiative that China oncology market implement in the future. However ZADAXIN is a very strong brand and our relationship through our supply chain and with our distributors are strong.

We believe that by working together with them we can create potential strategy whenever they might arise. Like Friedhelm I believe that 2014 has a potential to be high performance year for the SciClone sales and the marketing team. We are poised to execute well on our objectives.

Back to you, Friedhelm.

Friedhelm Blobel

Thank you, Hong. Now I would like to ask Wilson to discuss our financial performance for the fourth quarter and full year 2013 and our outlook for 2014. Wilson?

Wilson Cheung

Thanks, Friedhelm. Before I review our fourth quarter and full year 2013 financial results, I'd like to comment on five specific items. One, the effects of the non-renewal of the Sanofi agreement; two, the estimated settlement accrual we recorded for the SEC, DOJ investigations; three, the organizational restructuring and its related charges; four, the status update on internal controls over financial reporting; and five, our stock repurchase plan to-date.

First, our promotion agreements with Sanofi were not renewed and those agreements expired on December 31st. Friedhelm commented on this situation earlier in the call, so I would like to add some perspective on the situation. For the past five plus years, up until the fourth quarter, we consistently reached or exceeded our annual sales targets with Sanofi within a narrow band of plus or minus 10%.

Beginning in the fourth quarter however, Sanofi stopped paying invoices for promotion fees due to us and artificially reduced our orders substantially to only avail one-third of the expected quantities, forcing us to achieve below the annual sales target threshold and lowering the promotion fees to which we believe we are entitled.

Because of this and from an accounting perspective, we applied the same accounting methodology in recognizing revenues as in the past only through the end of the third quarter of 2013 and decided to report all fourth quarter related deliveries as deferred revenue under a lower promotional fee arrangement. The ultimate recognition of deferred revenue as real revenue awaits resolution of the dispute either through mutual negotiations which are still in progress as of today, or through arbitration.

Assuming revenues for the fourth quarter at the same run rate as in the first three quarters as of 2013, we would have earned an additional $9.8 million in revenues during the fourth quarter or approximately $0.18 more on our reported non-GAAP EPS. However due to the issues arising out of our relationship with Sanofi, we anticipate that the amount of any revenue from Sanofi that we may ultimately recognize related to the fourth quarter of 2013 will be less than such amount. With respect to the SEC, DOJ ongoing investigations, it is important to note that we are not yet in a position to predict what the outcome of those investigations will be or the timing of any resolution.

During the fourth quarter, we recorded a $2 million charge to reflect our estimate of a probable loss incurred related to potential penalties, fines and/or other remedies in the ongoing investigations. It should be noted that we could require to pay higher or lower fines or other penalties. I would like to reiterate that we remain absolutely committed to operating our business in compliance with U.S. laws and the laws of the territories where we operate with particular emphasis on the U.S. FCPA and with SOX 404 requirements including extensive internal audit programs to monitor our operations, robust compliance training and certifications for our employees, importers and distributors and increasing oversight and coordination from our U.S. corporate office.

In terms of our restructuring, recall that we announced a plan to reduce our workforce by about 100 to 150 people, primarily in sales and marketing in China. The restructuring was prompted by the nonrenewal of the Sanofi agreement. While the number of employees affected was significant; the expenses incurred and expected to be incurred were modest. Accordingly the restructuring resulted in severance related charges of approximately $1.2 million. As of December 31, we had paid $0.6 million of the accrued $1.2 million restructuring charge.

Now let me provide an update on our overall internal controls over financial reporting. As previously disclosed, we had a material weakness identified at the 2012 year end, which was comprised of several elements; deficiencies related to the timing of revenue recognition for Pfizer products, deficiencies related to the accounting for Aggrastat product return reserves, override of certain controls in the NovaMed financial statement close process, and the ineffectiveness of certain corporate monitoring controls. We are pleased that the first three elements have been fully remediated by the end of 2013.

Related to the element of corporate monitoring controls that will require additional time to mature and to demonstrate a stable history of operating effectiveness, this may take another quarter or two. As we have previously discussed, during the first-half of 2013, we experienced management turnover at the CFO and controller levels, as well as within the senior executive team. Since mid-July 2013 we have made significant enhancements within the organization at the senior level and implemented many new controls. Even with these new controls in place, prudence requires that these controls be demonstrated through satisfactory operating effectiveness for more than a single quarter, especially in a year of significant change in turnover. Therefore a material weakness will continue to exist at the end of 2013. We feel confident that we have an opportunity to remediate that this year.

Relative to our stock repurchase program, remember that in August 2013 our Board of Directors authorized an increase in the share repurchase program by $10 million to $50.5 million and extended the program through December 31, 2014. Approximately $40.8 million has been utilized through December 31, 2013. Approximately $9.7 million remains available. We continue to believe that our stock is undervalued and that the continuing stock repurchase program is in the best interest of our shareholders.

Now I would like to review our financial results for the fourth quarter and full year ended December 31. For purposes of this call, I would focus my commentary on full-year results. Please refer to our press release issued today for full details. Revenues for the full-year 2013 were $127.1 million, compared to $156.3 million for the full year of 2012. ZADAXIN revenues were $96.3 million for the full-year 2013, a $15.9 million or 14% decrease compared to a $112.2 million for 2012. Recall that our ZADAXIN product revenues in the first half of 2013 were adversely affected by the increase in channel inventory we experienced in the latter half of 2012. As previously disclosed we believe the channel inventory for ZADAXIN has returned to normalized levels.

On a GAAP basis, we reported net income of $11 million or $0.20 per share on both a basic and diluted basis for the year 2013, compared to net income of $9.6 million or $0.17 and $0.16 per share on a basic and diluted basis, respectively, for the full year 2012.

Our non-GAAP net income for the full-year 2013 was $23.2 million or $0.43 and $0.42 per share on a basic and diluted basis, respectively, compared to $37.8 million or $0.67 and $0.65 per share on a basic and diluted basis, respectively, for the same period of last year.

Our sales and marketing expenses for the full year 2013 were $55.8 million, compared with $70.3 million for the same period of last year. The decrease of $14.5 million in the 2013 period was a result of the expense saving measures we implemented in our sales and marketing activities with a goal of achieving profitability in all of our product lines.

Our research, development and expenses for the full year 2013 was $7.5 million, which included $5 million in upfront costs paid in 2013 related to new in-license arrangements with Zensun and Taiwan Liposome Company compared with $5.1 million of R&D expenses for the same period of last year.

Our general and administrative expenses for the full year 2013 were $32.5 million, compared with $21.3 million for the same period of last year. The increases were primarily attributable to higher legal and accounting costs associated with the ongoing government investigations, improvements to our FCPA compliance efforts, legal matters associated with the MEDA arbitration and bad debt expense.

Included in reported net income of $11 million for the full year 2013 is net other income of $2.8 million, which is primarily comprised of $2.6 million of other income resulting from an escrow settlement. On July 8, 2013, we and the representatives of the former stockholders of NovaMed entered into an escrow settlement agreement, pursuant to which we retained approximately $800,000 in cash and 342,300 shares of our common stock, having a combined fair value of approximately $2.6 million on the settlement date. As a result, we’ve recorded $2.6 million for the year ended December 31, 2013 in other income related to this settlement.

As of December 31, 2013, cash and cash equivalents, restricted cash and investments totaled $85.9 million, compared to $87 million as of December 31, 2012. As we have done in the past, we have presented non-GAAP information as we believe this non-GAAP information is useful for investors taken in conjunction with our GAAP financial statements because we use such information internally for our operating, budgeting and financial purposes.

Non-GAAP information is not prepared under a comprehensive set of accounting rules and should only be used to supplement an understanding of our operating results as reported under GAAP. The non-GAAP calculations and reconciliation are provided in the table in the press release titled reconciliation of GAAP to Non-GAAP Net Income.

Now relative to our guidance for 2014, we project our 2014 revenue to be in the range between $130 million and $135 million and our non-GAAP earnings per share to be in the range of $0.41 and $0.47. The mid-point of the revenue guidance represents more than 25% of our core business, which excludes revenues from discontinued promotion services agreements. We also project that cash and investments as of December 31, 2014 will be greater than 100 million, which excludes the cash impact of annual purchases of common stock during 2014, in-licensing related payments, Zensun loan drawdown and any additional probable loss in excess of the $2 million currently reserved related to our ongoing investigation with the Securities and Exchange Commission and the Department of Justice.

With that, I will now turn the call back over to Friedhelm.

Friedhelm Blobel

Thank you, Wilson. Now I would like to ask the operator to open the call for questions. Operator?

Question-And-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Hamed Khorsand with BWS Financial. Please proceed.

Hamed Khorsand - BWS Financial

The first question I had was what made you decide that you need to take a $2 million reserve on this DOJ? What made you say okay, $2 million is a figure to start off with?

Friedhelm Blobel

Wilson?

Wilson Cheung

Yes, this is Wilson. Let me take this question. This is really an accounting accrual where if the company believes that there is a good probability that we would incur a loss and we can actually make a reasonable estimate, then from the accounting perspective we do need to make an agreement -- we do need to make an accrual. But like I said earlier this is not a final number. This is just based on GAAP accounting that once we believe that management expected that there is a probable loss and we can make an estimate, then we would have to book this.

Hamed Khorsand - BWS Financial

Are we anywhere closer to a resolution on this matter?

Wilson Cheung

Not all I think [indiscernible]. Not at this point the investigation is still ongoing and as soon as we have any news that we would be able to announce, we will do so accordingly.

Hamed Khorsand - BWS Financial

Okay. Then the other question I have was on the ZADAXIN side. Your inventory went up substantially in Q4 but you’re saying you’re back to normal [indiscernible] reason why inventory was so high?

Friedhelm Blobel

Sorry Hamed I am not quite sure what your question is. We have mentioned that as of mid of 2013, inventory levels for ZADAXIN was back to normal and that is what we continue to see and on that basis we have operated in the second half of 2013.

Hamed Khorsand - BWS Financial

Friedhelm, what I was referring to was the $15.2 million inventory at the end of Q4, compared to Q3 when you ended with $9.8 million of inventory on hand.

Friedhelm Blobel

I’m not 100% sure exactly regarding those inventory dollar numbers, but what I'm sure is that we are back since mid-last year. Maybe Hong you could add something to that.

Hong Zhao

So what is the methodology how to captivate our CIO actually is based on the last three amount sales average divided by the inventory level. So actually is given our sales, in line [ph] sales in the second half of the year and Q4 especially. So overall our base PIO actually is an inventory base in the normal label.

Hamed Khorsand - BWS Financial

And then do you think you’re facing headwinds as far as growth goes? I mean you were talking about increased generic growth care. So is growth going to…?

Friedhelm Blobel

You broke up. Something regarding growth? But we have been able to grow consumption in the hospital level in 2013 on the double-digit level and we see that this could and want to achieve the same in 2014 and so far we’re off to a good start and I think yes there is definitely some growth and the ZADAXIN market, that segment is also growing 16% to 17% as we mentioned.

Operator

Your next question comes from the line of Tim Lynch with Stonepine Capital. Please proceed.

Tim Lynch - Stonepine Capital

The guidance for 2014 on the earnings side, what does that assume in terms of your extraordinary legal expenses for the year which I know you've described as quite a hit to your expenses in the last few years.

Friedhelm Blobel

I just want to add that this is certainly correct that the expenses have been very substantial and we assume all throughout 2014 that there will continue to be price potential, and that has quite an impact also on earnings in the guidance. Wilson, do you have some more color for that?

Wilson Cheung

Yes ,the only thing I want to supplement Tim, is that for the 2014 budget, obviously we have put in some conservatism in place and we have budgeted roughly around $7 million in terms of legal fees for the ongoing investigation.

Tim Lynch - Stonepine Capital

Okay. Does that include possible charges?

Wilson Cheung

No.

Tim Lynch - Stonepine Capital

Okay. So if you had a resolution midyear, there could be upside on your earnings regarding that element?

Wilson Cheung

Absolutely. The sooner that we resolve the issue, the sooner that we can save the budgeted legal fees associated with that matter.

Tim Lynch - Stonepine Capital

Okay, great. Share repurchases, just doing quick math, I'm not sure if it’s right. It looks like you bought $2.6 million worth in the quarter of shares. Is that roughly right?

Wilson Cheung

We purchased $2.8 million worth in the fourth quarter. Bear in mind that in a closed window, which was primarily most of the Q4 we have limited amount of shares that we can purchase. As of to date, as I mentioned earlier on my prepared comments, we still have $9.7 million left for the remainder of 2014. Obviously we believe that the program is running very well and Friedhelm can also attest to this -- once we approach close to the $50 million target, then chances are likely we’ll go to the Board and ask for more.

Tim Lynch - Stonepine Capital

Do you expect more restructuring charges related to the restructuring already implemented in Q1?

Wilson Cheung

The restructuring program actually would lapse a couple of quarters and the entire restructuring probably will end sometime in the second quarter of this year. However we have already made all the related accruals in the fourth quarter. So you will not see additional restructuring charges in 2014.

Tim Lynch - Stonepine Capital

Just in terms of the Sanofi situation, if you go into arbitration or into an actual law suit, what jurisdictions are you dealing with for those?

Friedhelm Blobel

The arbitration would be in China, it’s a local agreement. So it will be arbitration according to CIETAC rules, which is the local arbitration body.

Tim Lynch - Stonepine Capital

Okay. And any…

Friedhelm Blobel

We haven’t given up the hope that we might find a compromise and a settlement but it’s too early to predict which way this will go.

Tim Lynch - Stonepine Capital

Okay. Hepatitis B, you mentioned is increasing in prevalence and incidences in China. Is that really, I wasn’t aware of that as a case and to what magnitude are you talking about the growth in that patient population?

Friedhelm Blobel

It’s a good opportunity and our product fits right into it and is certainly becoming more of an issue and on the other hand certainly the vaccination programs do show some effect but the prevalence rights remain quite high but little north of 7%. So, we feel that there is a good opportunity because there is a lot of experience with combining the typical antivirals which are typically anti-caviar generics with thymalfasin and we want to certainly actively address that.

Tim Lynch - Stonepine Capital

And did I hear you right on your prepared comments that that patient population is actually growing?

Friedhelm Blobel

Well, I wouldn’t say that it is growing, but I think the opportunity has not been diminished. It is still there and we feel that they are good experiences and we could, for us see, we see there really a chance to get some growth.

Tim Lynch - Stonepine Capital

Okay. It was in your press release. It says for example the incidents and prevalence of hepatitis B expands.

Friedhelm Blobel

Yes, it is just north of 7%.

Tim Lynch - Stonepine Capital

So those are both growing then?

Friedhelm Blobel

I can’t tell you exactly the number, which it was, but it is kind of surprisingly high still because for a long time the expectation was that it would, through the vaccination programs get smaller but you can’t see that so far.

Tim Lynch - Stonepine Capital

Okay. I would take expand [ph] growth that may be in your press release it doesn’t mean growth. Okay, and material weakness, thanks for the color on that Wilson. It sounds like the last remaining item is merely a function of operating successfully just over time. What are the implications of that being resolved, your material weakness? And are there savings expenses or any other ends or is it just your reporting will be clean in a sense?

Wilson Cheung

The gist of the remaining action items that we need to do is to continue to show the consistency of the monitoring controls that already has been put in place in the fourth quarter. So, for example, both myself and the VP, Finance and Corporate Controller, would have to spend more time in China, in Hong Kong to be involved in the close of the local books. We have already been doing that since October. We have done the testing. We have already passed those tests on a monthly basis but again we can only show to the auditors one quarters’ worth of results. And given what’s going on in the last year, obviously it’s not good enough. So we would have to continue to show the auditors that we are not just putting the bandaid in there. This is really a fundamental change in terms of how we actually close our books and we need to show to the auditors that we are continuing to do that in 2014.

Tim Lynch - Stonepine Capital

Okay. Last question I have is just on taxes. Do you see any change in your tax rate in the next several years of a meaningful amount?

Wilson Cheung

Right now, Tim the effective tax rate is in the mid-teens and it’s really not apples-to-apples compared to last year for example, because last year when we took the write down of the intangible assets, we also took pretty significant tax benefit. But having said, as you know we still have the large NOL on the U.S. side and therefore it’s only the SciClone fee -- that is the only entity that we’re paying taxes and that’s roughly at about let’s say $2 million to $3 million a year. So in the longer term to answer your question, I guess as we increase more offshore income, that is going to reduce our overall effective tax rate because the offshore effective tax rate is actually much lower and roughly between 7% to 8%. So the answer is yes we’re trying to control that so that we’re going to try to manage our company in a way that we have more offshore income that inshore.

Operator

Your next question comes from the line of Yi Chen with Aegis Capital. Please proceed.

Yi Chen - Aegis Capital

My first question is that cost of product sales this quarter is much higher than the previous quarter. Is that because you did not recognize Sanofi promotion fees, but still recognize those costs incurred?

Wilson Cheung

That is correct.

Yi Chen - Aegis Capital

Second question. Could you comment on the current state of the sales team? How many people are there and do you plan to maintain that size going forward for the next two years?

Friedhelm Blobel

So we have about 500 sales reps. The majority, 350 or a little north of that are focused on ZADAXIN. We have about 100 on cardiovascular and the balance for the oncology team and we will grow the sales team with growth of revenues, maybe not quite this same growth rate but with a somehow lower growth rate. But we will expect to expand the sales team. Once the revenues grow of this core business, then we also will expand again the sales team.

Yi Chen - Aegis Capital

Okay when do we expect to see the result of the MEDA arbitration?

Friedhelm Blobel

We expect this quarter -- I think they’re getting to be end of the arbitration and it could happen anytime. But we don’t know anything as of this minute. So I'd expect it this quarter.

Yi Chen - Aegis Capital

Okay. Finally, can you update us on the development status of the products in the original pipeline say DCB, lower mix revenue and rapid film? Is there any chance that any of them can get on the market this year or next year?

Friedhelm Blobel

The potential candidate is DCB. That’s most advanced. I think the others are not that close that 2014, they could reach the market but it is a possibility for DCB but obviously the decision of the regulatory agency has not been taken and we have submitted all the documentation but it’s always hard to predict when they will come up with conclusion and make a decision.

Operator

(Operator Instructions) We have no further questions.

Friedhelm Blobel

All right. So I would like to thank all for participating in our quarterly conference call. Please feel free to contact us directly should you have any further questions. Thank you very much.

Operator

Thank you for your participation in today's conference. This concludes the presentation. Everyone may now disconnect and have a good day.

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