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SciClone Pharmaceuticals (NASDAQ:SCLN)

Q1 2014 Results Earnings Conference Call

May 12, 2014, 8:30 a.m. 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

Yi Chen - Aegis Capital

Operator

Good day, ladies and gentlemen, and welcome to the Q1 SciClone Pharmaceuticals Inc. earnings conference call. [Operator instructions.] I would now like to turn the conference over to Jane Green in SciClone’s investor relations group. Please proceed.

Jane Green

Thank you, and 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 first quarter 2014 financial results. We are pleased with the performance of our core business in the first quarter, and are confident that we remain on track to achieve our 2014 financial goals, consistent with the guidance we provided at the end of 2013.

The revenues of our core business, which include ZADAXIN, Aggrastat, and all Pfizer and Baxter products, grew 31% year over year. ZADAXIN also continued to grow at an attractive pace.

Building further on the growth rate achieved in the fourth quarter of 2014, ZADAXIN hospital sales growth was in line with the overall growth rate for drugs in China in the first quarter and, in terms of revenue, represented a 30% increase compared to the first quarter of 2013.

We are pleased that ZADAXIN sales growth is keeping pace with the overall China pharmaceutical market growth rate, which has also rebounded from its low in the third quarter of 2013. As Hong will discuss in a few minutes, we believe that our enhanced sales and marketing activities and implementation of our wider and deeper strategy to penetrate further into tier one and two cities and large hospitals are succeeding in having a positive impact and that our ZADAXIN business unit is performing at a high level.

Our cardiovascular, primary care, and oncology business units are also making progress toward achieving their goals for the year. Our recorded decrease in revenues in the first quarter 2014, compared to the first quarter of 2013, is reflective of the internal and external challenges we faced in 2013.

We have overcome those challenges, and they’re largely in the past. In the first quarter, we did feel the revenue impact of the expiration of the promotional service agreement with Sanofi at the end of their term on December 31, 2013, as revenues from our promotion business were entirely derived from our Pfizer and Baxter agreements.

With respect to our relationship with Sanofi, they’re also pursuing settlement options outside of formal arbitration, and I’m hopeful that we may come to mutually acceptable terms in the near future.

We are also pleased that within the last several weeks, a final award of the Arbitral Tribunal in the arbitration with MEDA has been issued. In his remarks, Wilson will also provide an update on the terms of the award.

We are glad to be in a position to begin putting these distractions behind us, and to focus our energies on continuing to grow our core business. I’m pleased to note that we are making substantial progress in renewing our promotion agreement with Pfizer, which has been undergoing extensive and detailed review within the Pfizer organization over the past several months.

During this negotiation period, we have been operating on a month to month contractual basis. We are optimistic about being able to consummate a longer-term renewal with Pfizer in the near term, with improved economics.

We also have several promising business development discussions underway with potential collaborators, and are hopeful of being in a position to establish additional industry partnerships that can expand our product portfolio and have a positive near term impact on our revenue and profitability.

Our outlook for 2014 and for our overall long term growth continues to be positive and in line with our expectations. We continue to believe that ZADAXIN can be a strong growth driver for our company, through market expansion in the current indications for which it is approved, as well as potential new indications.

Our organization is performing at a high level, and our management team [unintelligible] in China are aligned and collaborative. We continue to believe that the significant enhancements we have made in our business practices and accounting controls and in intensifying our focus on company-wide compliance will continue to strengthen our business and our reputation in the China pharma market and in the global investment community.

We continue to believe that SciClone represents a unique opportunity for investors who appreciate the growth opportunities and risk mitigation strategies of the specialty pharmaceutical model, and who want to take advantage of the growth of the China pharmaceuticals market.

We believe that our strong commitment to constant improvement in our controls and compliance practices is a major business asset and market differentiator, and positions us well as an eligible industry partner.

Now, I would like to ask Hong to share his perspective on the first quarter with us. Hong?

Hong Zhao

Thank you, Friedhelm. I would like to comment on the positive trends we saw take shape in the first quarter of 2014. Starting with an external market review, we are pleased to see that the China pharmaceutical market continued to return largely to its normal state over the last several months.

You may recall that the industry as a whole experienced a pullback starting in the third quarter of 2013, largely as a result of the uncertainty created by the government’s focus [unintelligible]. In response to the pressure, hospital customers stopped meeting with pharma sales and marketing professionals. In addition, pharma companies significantly reduced their commercial outreach activities to focus on strengthening their internal [comparative] programs. This pullback negatively impacted sales growth throughout the industry.

That negative trend began to reverse in the fourth quarter of 2013. Today, we see that the pharma sector has continued to recover, sales growth has returned to the 16% to 18% range and the interaction between the sellers and the buyers is back to normal.

Let me now say that emphasis on compliance has [unintelligible] on the country. Pharma companies have continued to focus on enhancing compliance activities. We believe that SciClone, with its long history of constantly improving compliance and a strong management focus on [ethical sales practice], continues to be seen as a high-quality company with an excellent reputation as a [unintelligible] and as a partner of choice.

As additional perspective on the industry, the Chinese government continued to deepen programs on a [unintelligible] basis that are designed to increase [unintelligible] access and coverage, and encourage industry innovation, and at the same time, contain the growth of the sales [unintelligible].

One of the [unintelligible] programs being [input] in the [unintelligible] provincials was to most significantly reduce the hospital pharmacy back up on drug price. This strategy will impact hospital [unintelligible], but not directly impact the price companies can charge for drugs.

The [unintelligible] for this strategy is to discourage hospitals from overprescribing drugs. It will have the benefit effect of reducing the price consumers would pay, thus satisfying patient demand and at the same time [unintelligible] with rationale for the healthcare system.

From an internal perspective, we are very pleased with the [unintelligible] growth in the first quarter, which exceeded our expectations and built on the growth trend in the third quarter of 2014. We believe that the strategy we have implemented to streamline and optimize our sales and marketing team and the focus on the key target hospitals are having a positive effect on driving ZADAXIN demand.

We have been able to increase penetration in additional hospital departments, such as the hospitals specializing in the treatment of hepatitis B and in intensive care units. We have also been successfully increasing the number of customers we sell into the existing hospital departments.

Looking forward, we seek to maintain the momentum in our ZADAXIN business by increasing our medical marketing activities. We are also optimizing so that we can see the growth in our oncology business and our [unintelligible] cardiovascular business, especially now that the Pfizer agreement is advancing toward finalization.

We are pleased that our organization is stable and commercial, and our leadership team is performing at a very high level. Back to you, Friedhelm.

Friedhelm Blobel

Thank you, Hong. Now I would like to ask Wilson to discuss our financial performance for the first quarter 2014. Wilson?

Wilson Cheung

Thanks, Friedhelm. Before I review our first quarter 2014 financial results, I’d like to provide some additional color on Friedhelm’s comments regarding our arbitration results with MEDA, a quick update on our ongoing SEC/DOJ investigations, and the status of our stock repurchase program.

First, with respect to MEDA, on April 3, 2014, an arbitration award was announced in our favor. In summary, the arbitration panel supports MEDA’s termination of our contract, but stipulates that if MEDA wishes to have the product rights in China, the company must compensate us for the services we performed in developing the products.

If MEDA does not wish to repossess these rights, or fails to pay us, the rights do not have to be returned. We have made a request to MEDA to compensate us in the amount of $3.3 million. Such potential gain would be recorded in a future period, assuming MEDA does not further contest our award calculation and makes the full payment in exchange for us returning the product rights.

Second, with respect to the SEC/DOJ ongoing investigations, we have reassessed the potential liability in this matter with no significant developments noted in the current quarter and therefore cannot yet predict what the outcome of those investigations will be, or the timing of any resolution.

As we reported earlier in March, 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 be required to pay higher or lower fines or other penalties.

Relative to our stock repurchase program, of the $50.5 million authorized for this program by the board of directors, approximately $43.4 million has been utilized through March 31, 2014, and approximately $7.1 million remains available. We intend to continue our share repurchase program, which we strongly believe is a value-creating strategy for our stockholders.

Now, I would like to review our financial results for the first quarter 2014. Please consult the press release we issued today for full details. Revenues for the first quarter 2014 were $26.6 million, compared to $29.8 million for the same period in 2013.

ZADAXIN revenues were $24.7 million for the first quarter of 2014, a $5.7 million, or 30%, increase compared to $19 million in the same period in 2013. Recall ZADAXIN product revenues in the first half of 2013 and the fourth quarter of 2012 were adversely affected by the increase in channel inventory we experienced in the latter half of 2012, and which has been returned to normal levels.

Promotion services revenues were $0.5 million for the first quarter of 2014, derived mainly from our product promotion agreement with Baxter. As a result of the expiration of the promotion agreements with Sanofi at the end of their term on December 31, 2013, our promotion agreement revenues were $8.8 million or 95% lower, compared to $9.3 million recorded in the same period in 2013.

On a GAAP basis, we reported net income for the first quarter of 2014 of $4.1 million, or $0.08 per share on both a basic and diluted basis for the first quarter of 2014, compared to net income of $4.2 million for the same period in the prior quarter or $0.08 per share on both a basic and diluted basis for the same period in the prior year.

Our non-GAAP net income for the first quarter of 2014 was $5 million or $0.10 and $0.09 per share on a basic and diluted basis, respectively, compared to $5.2 million, or $0.10 and $0.09 per share on a basic and diluted basis, respectively, for the same period of last year.

Sales and marketing expenses for the first quarter of 2014 were $9.8 million, compared with $11.2 million for the same period of the prior year. We restructured our sales force in the fourth quarter of 2013 related to the expiration of our Sanofi distribution agreements and our sales force has been reduced by over 200 sales persons by March 31, 2014, compared to one year ago.

In addition, sales and marketing expenses decreased for the first quarter of 2014 related to the expiration of our Sanofi agreements and the reduction in cost associated with marketing the products under these agreements. These reductions were partially offset by growth in our sales and marketing efforts for ZADAXIN.

Research and development expenses for the first quarter of 2014 were $1.5 million, compared with $0.4 million of R&D expenses for the same period of last year, an increase of $1.1 million, primarily related to costs incurred in the evaluation of potential [unintelligible] clinical studies for ZADAXIN.

General and administrative expenses for the first quarter of 2014 were $6 million compared with $8.6 million for the same period in the prior year, primarily related to lower legal costs associated with the ongoing government investigation and other legal matters and lower accounting fees continue to costs incurred in the prior year period related to the restatement of our consolidated financial statements for the year ended December 31, 2011 and certain quarters of 2011 and 2012.

As of March 31, 2014, cash and cash equivalents, restricted cash, and investments totaled $87.5 million continue to $85.9 million as of December 31, 2013. Consistent with past practices, 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 planning 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 reconciliations are provided in the accompanying table in today’s press release, titled “Reconciliation of GAAP to non-GAAP net income.”

Finally, our 2014 revenue and non-GAAP EPS guidance remains unchanged at $130 million to $135 million, and between $0.41 and $0.47 respectively. 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.] Your first question comes from Hamed Khorsand from BWS Financial.

Hamed Khorsand - BWS Financial

As far as the cash balance goes, there was a significant decrease in accounts receivable, and inventory also declined sequentially, but the cash balance didn’t increase much at all this quarter.

Wilson Cheung

This is very typical for first quarter. If you recall, in the year end, normally, we would have AR balances, but we have actually collected quite a substantial amount of cash, and therefore our AR balances come down. But at the same time, we also look at the AP side. We also accrued a high amount of AP for legal fees, accounting fees, and what have you, and we also paid those down accordingly.

So in terms of the inventory, we had a little bit of higher inventory balance last year, primarily due to some of the additional labeling work that we did. But we have already pulled that down to more normal levels, in our minds.

Hamed Khorsand - BWS Financial

And do you have any outstanding receivables from Sanofi at this time?

Wilson Cheung

Yes, we do still have about $3.5 million worth of AR with them, and as Friedhelm has mentioned in his prepared comments, we are also exploring settlement negotiations with them. And hopefully, this will come to fruition the very near future, and then we will get paid on our AR.

Hamed Khorsand - BWS Financial

And I didn’t hear you guys talk about any R&D efforts, but R&D expenses increased this past quarter.

Friedhelm Blobel

We have mentioned before that we were looking, if it could make sense to consider an approach with ZADAXIN in sepsis for non-China markets. We have done a couple of evaluations in that regard, and the conclusion for that is very recently that it does not make sense, because the cost would be too high to really do that. In parallel, we certainly have all the time and continue to do the further work for sepsis in China, particularly the work to make sure that we can include it in the treatment guidelines.

Hamed Khorsand - BWS Financial

And just from an overall market standpoint, for ZADAXIN in China, it seems like you’re growing revenue by expanding your presence in different hospitals. So another way I’m trying to look at it is, do you think you’re losing share at the tier one hospitals, or in one of your more established hospitals, that you need to grow with new customers?

Friedhelm Blobel

No, I think particularly in the last quarters, we haven’t lost share. And the trend is certainly also a countrywide trend that growth comes also from the rural areas, not only from the hospitals. So from what we know, we are keeping our share quite nicely.

Operator

Your next question comes from Yi Chen from Aegis Capital.

Yi Chen - Aegis Capital

My first question is, could you please remind us the seasonal fluctuation in hospital ordering patterns for ZADAXIN from quarter to quarter?

Friedhelm Blobel

Well, I mean, it’s not necessarily ordering patterns, but there is a certain seasonality in terms of the sales numbers. And that seasonality is that Q2 and Q3 are about 25% of the annual volume while Q1 is clearly lower and Q4 is clearly higher. And over the years, we have seen anything from 20% to 22% of the annual volume in the first quarter and 28% to 30% in the fourth quarter.

And the reason is mainly in Q1 Chinese New Year, which makes it a shorter period, and people seem to get less sick, or less frequently sick, as strange as that may sound.

Yi Chen - Aegis Capital

My second question is what is the gross margin of ZADAXIN that we should expect for this year?

Friedhelm Blobel

Well, I think there are various numbers which play into this, and I think we are confident that it should be north of 25% on a revenue basis.

Yi Chen - Aegis Capital

Regarding the sales and marketing costs, should we expect to remain at current level for the foreseeable quarters?

Friedhelm Blobel

Yes, I think sales and marketing, we should have reached that level. The restructuring was mainly done in Q4, so that should be stable now with where we are, and obviously on the cost side, there shouldn’t be too much fluctuation.

Yi Chen - Aegis Capital

Final question is regarding the MEDA arbitration. You mentioned that the committee decided that if MEDA wishes to market a drug in China, they will need to pay SciClone a developing cost. So do you know whether MEDA has indicated when or if they will market this drug in the China market?

Friedhelm Blobel

No, they have not given us any indication in that regard. We have fulfilled our part, which the arbitration tribunal asked us to do, which is to quantify the numbers. Wilson mentioned that number of $3.3 million. These have been the various cost elements which we have spent in bringing the MEDA product to that level.

And it’s now up to MEDA to make a simple final decision to either market these products and then they will have to pay us this amount and we will hand over the various documents, the registration approval for [tramodol] as well as the data, the completed clinical study report for budesonide. And we have made it clear to them that we will do this in the most constructive way, or if they’re not interested to market these two drugs in China, then that would be probably the closing of this topic.

Operator

I would now like to turn the call back over to Dr. Blobel for closing remarks.

Friedhelm Blobel

Thank you, everybody, for participating in our quarterly conference call today. Please feel free to contact us directly should you have any further questions. We appreciate your attention. Thank you.

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Source: SciClone Pharmaceuticals' (SCLN) CEO Friedhelm Blobel on Q1 2014 Results - Earnings Call Transcript

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