Accounts receivable represent amounts due from Sucampo under the joint exclusive worldwide royalty-bearing license agreement (see Note 3). The Company has not recorded an allowance for doubtful accounts at either September 30, 2010 or December 31, 2009 because the amounts were subsequently paid in full.
Notes Receivable, Related Parties
Notes receivable, related parties represent outstanding balances from a note receivable issued to a relative of the Company’s owners and a note receivable to a company controlled by the Company’s owners (Note 3). The Company has not recorded an allowance for doubtful accounts at September 30, 2010 because the amounts were paid in full in December 2010.
Certain Risks, Concentrations and Uncertainties
Financial instruments that subject the Company to concentrations of credit risk consist of cash and receivables. The Company places its cash with highly rated financial institutions. The Company has not experienced any losses on these accounts related to amounts in excess of insured limits.
The Company depends significantly upon the joint exclusive worldwide royalty-bearing license agreement with Sucampo (see Note 3) and if this relationship is disrupted, it will have a material adverse impact on the Company. Revenues from Sucampo accounted for 100% of the Company’s total revenues for the nine month periods ended September 30, 2010 and 2009 and year ended December 31, 2009. Accounts receivable due from Sucampo accounted for 100% of the accounts receivable, related parties balance as of September 30, 2010 and December 31, 2009.
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include cash, receivables, accounts payable and accrued expenses, approximate their fair values based on their short maturities.
Property and Equipment
Property and equipment are recorded at cost and consist of office equipment, furniture and fixtures, vehicles and leasehold improvements. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. Significant additions and improvements are capitalized. Expenditures for maintenance and repairs are charged to earnings as incurred. When assets are sold or retired, the related cost and accumulated depreciation are removed from the respective accounts and any resulting gain or loss is included in earnings.
Impairment of Long-lived Assets
All of the Company’s long-lived assets, which include intangible assets and property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. If indications are present, the Company would test for recoverability by comparing the carrying amount of the asset to the net undiscounted cash flows expected to be generated from the asset. If the estimated net undiscounted cash flows do not exceed the carrying amount, the Company would determine the fair value of the asset and record an impairment charge, if any. There have been no impairment charges recorded during the nine month periods ended September 30, 2010 and 2009 or the year ended December 31, 2009.
Revenue Recognition
The Company’s sources of revenue are based on the joint exclusive worldwide royalty-bearing license agreement with Sucampo (see Note 3). Product royalties, related parties represent revenues earned from Sucampo received from third parties during commercialization of its product, AMITIZA, for generally 3.2% of AMITIZA net sales. Milestone royalties, related parties represent revenues earned from Sucampo for milestones Sucampo received from third parties during development of its product, AMITIZA. The Company recognizes revenue from these sources when milestones are earned or when third-party results for the net sales of AMITIZA are reliably measurable, collectability is reasonably assured and all other revenue recognition criteria are met.
SUCAMPO AG
Notes to Consolidated Financial Statements
Operating Expenses
Operating expenses consist primarily of personnel costs, office, maintenance and defense of intellectual property costs, director fees and professional fees for legal and accounting services.
Foreign Currency Losses
Foreign currency losses consist primarily of foreign exchange losses related to cash deposits held at banks.
Income Taxes
The Company accounts for income taxes under the asset and liability method in accordance with the relevant guidance for accounting for income taxes, which requires companies to account for deferred income taxes using the asset and liability method. Under the asset and liability method, the current income tax provision or benefit is the amount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carryforwards. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Tax rate changes are reflected in the income tax provision during the period such changes are enacted.
Uncertain Tax Positions
The Company applies the accounting guidance for uncertain tax positions that requires the application of a more likely than not threshold to the recognition and derecognition of uncertain tax positions. If the recognition threshold is met, the Company recognizes a tax benefit measured at the largest amount of the tax benefit that, in its judgment, is more than 50 percent likely to be realized upon settlement.
The Company has recorded a non-current income tax liability of approximately $607,000 and $527,000, including interest and penalties, for uncertain tax positions as of September 30, 2010 and December 31, 2009, respectively, which is presented as other liabilities in the consolidated balance sheets. The amount represents the aggregate tax effect of differences between tax return positions and the amounts otherwise recognized in the Company’s consolidated financial statements. This liability for uncertain tax positions mainly pertained to SAG-J being thinly capitalized upon incurring its intercompany debt with SAG and income tax withholdings from SAG-J’s interest income.
The Company recognizes interest and penalties related to uncertain tax positions as a component of the income tax provision. The Company has identified no uncertain tax position for which it is reasonably possible that the total amount of liability for unrecognized tax benefits will significantly increase or decrease within 12 months, except for recurring accruals on existing uncertain tax positions.
Foreign Currency
The Company translates the assets and liabilities of its foreign subsidiary, SAG-J, from Japanese Yen (SAG-J’s functional currency) into Swiss Francs (SAG’s functional currency), at the current exchange rate in effect at the end of the year and maintains the capital accounts of this subsidiary at the historical exchange rates. The revenue, income and expense accounts of SAG-J are translated into Swiss Francs at the average rates that prevailed during the relevant period. The gains and losses that result from this process are presented in accumulated other comprehensive income in the consolidated balance sheets.
SUCAMPO AG
Notes to Consolidated Financial Statements
The Company is presenting these consolidated financial statements with a reporting currency of the U.S. dollar. SAG’s consolidated financial statements prepared in its functional currency are remeasured to the U.S. dollar based on a consistent methodology for how SAG-J’s account balances are remeasured to SAG’s functional currency.
Realized and unrealized foreign currency gains or losses on assets and liabilities denominated in a currency other than the functional currency are presented in foreign currency losses, net in the consolidated income statements.
Other Comprehensive Income
Comprehensive income consists of net income plus certain other items that are recorded directly to stockholders’ equity. For the nine months ended September 30, 2010 and 2009 and year ended December 31, 2009, the only such items recorded directly to stockholders’ equity were foreign currency translation amounts. The Company has presented comprehensive income in the consolidated income statements and statements of comprehensive income.
Recent Accounting Pronouncements
In February 2008, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance which delayed the effective date of the guidance for fair value measurements for one year for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. This statement partially deferred the effective date to fiscal years beginning after November 15, 2008. The Company adopted the provisions of this guidance effective January 1, 2009 and such adoption did not have a material impact on the consolidated financial statements.
In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities, or VIEs. The elimination of the concept of qualifying special-purpose entities, or QSPEs, removes the exception from applying the consolidation guidance within this amendment. This amendment requires an enterprise to perform a qualitative analysis when determining whether or not it must consolidate a VIE. The amendment also requires an enterprise to continuously reassess whether it must consolidate a VIE. Additionally, the amendment requires enhanced disclosures about an enterprise’s involvement with VIEs and any significant change in risk exposure due to that involvement, as well as how its involvement with VIEs impacts the enterprise’s financial statements. Finally, an enterprise will be required to disclose significant judgments and assumptions used to determine whether or not to consolidate a VIE. This amendment is effective for financial statements issued for fiscal years beginning after November 15, 2009. The Company adopted the guidance effective January 1, 2010 and such adoption did not have a material impact on the consolidated financial statements.
In September 2009, the FASB issued an amendment to the authoritative guidance which addresses how revenues should be allocated among products and services in a singular sales arrangement. The guidance establishes a hierarchy for determining the selling price of each product or service, with vendor-specific objective evidence, or VSOE, at the highest level, third-party evidence of VSOE at the intermediate level, and management's best estimate at the lowest level. It replaces “fair value” with “selling price” in revenue allocation guidance. It also significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. This guidance will be effective prospectively for agreements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company is continuing to evaluate the impact that this amendment would have on its financial condition and results of operation upon adoption.
In January 2010, the FASB issued authoritative guidance on improving the disclosures about fair value measurements. This guidance requires additional disclosures about fair value measurements including transfers in and out of Levels 1 and 2 and a higher level of disaggregation for the different types of financial instruments. For the reconciliation of Level 3 fair value measurements, information about purchases, sales, issuances and settlements should be presented separately. This guidance is effective for annual and interim reporting periods beginning after December 15, 2009 for most of the new disclosures and for periods beginning after December 15, 2010 for the new Level 3 disclosures. The Company adopted the relevant guidance effective January 1, 2010 and such adoption did not have a material impact on the Company’s consolidated financial statements.
SUCAMPO AG
Notes to Consolidated Financial Statements
In March 2010, the FASB issued authoritative guidance on applying the milestone method to milestone payments for achieving specified performance measures when those payments are related to uncertain future events. Under this guidance, an accounting policy election can be made to recognize arrangement consideration received for achieving specified performance measures during the period in which the milestones are achieved, provided certain criteria are met. This guidance is limited to transactions involving research or development. This guidance is effective for annual and interim reporting periods beginning on or after June 15, 2010 and may be early adopted. Since the Company elected to continue to use the existing revenue models, the relevant guidance has not been adopted.
3. Related Party Transactions
Sucampo
On June 30, 2006, the Company entered into a restated patent license agreement with Sucampo. Under this agreement, the Company has granted to Sucampo a royalty-bearing, exclusive, worldwide license, with the right to sublicense, to develop and commercialize AMITIZA, cobiprostone and SPI-017 and any other prostone compounds, other than Rescula, subject to the Company’s patents. This agreement supersedes all previous license and data sharing arrangements concerning AMITIZA, cobiprostone and SPI-017 between the parties and functions as a master license agreement with respect to the Company’s prostone technology. The license is perpetual as to AMITIZA, cobiprostone and SPI-017 and cannot be terminated unless Sucampo breaches its obligations to the Company. If Sucampo has not committed specified development efforts to any prostone compound other than AMITIZA, cobiprostone and SPI-017 by the end of a specified period, which ends on the later of June 30, 2011 or the date upon which the founders no longer control Sucampo, then the commercial rights to that compound will revert to the Company, subject to a 15-month extension in the case of any compound designated by Sucampo in good faith as planned for development within that extension period. Under the terms of the license, Sucampo is obligated to assign to the Company any patentable improvements derived or discovered by Sucampo relating to AMITIZA, cobiprostone and SPI-017 through the term of the license. In addition, Sucampo is obligated to assign to the Company any patentable improvements derived or discovered by Sucampo relating to other licensed prostone compounds prior to the date which is the later of June 30, 2011 or the date on which the founders cease to control Sucampo. All compounds assigned to the Company under this agreement will be immediately licensed back to Sucampo on an exclusive basis.
Sucampo is required to pay the Company, on a country-by-country basis, ongoing patent royalties as follows:
| ● | During the period from the first commercial sale until all of the pre-IPO patents that could be infringed by the sale of the products have expired, a royalty of 2.2% of net sales of AMITIZA in North, Central and South America, including the Caribbean; and 4.5% of net sales of AMITIZA in other territories or sales of other compounds. These royalties are payable until the last pre-IPO patent covering each relevant compound in the relevant country has expired. |
| ● | Thereafter until such time as all remaining licensed patents that would be infringed by the sale of such licensed product have expired in the country of sale, a royalty of 1.1% of net sales of AMITIZA in North, Central and South America, including the Caribbean; and 2.25% of net sales of AMITIZA in other territories or sales of other compounds. |
| ● | For the licenses granted under the agreement, a royalty of 1% of net sales of AMITIZA in North, Central and South America, including the Caribbean; and 2% of net sales in the case of sales of AMITIZA in other territories or sales of other compounds; and |
| ● | Upon expiration of the 15th anniversary of the first commercial sale of the licensed products, the licenses shall be royalty free. |
The product royalties that Sucampo pays to the Company are based on total product net sales, whether by Sucampo or a sublicensee, and not on amounts actually received by Sucampo.
SUCAMPO AG
Notes to Consolidated Financial Statements
In consideration of the license, Sucampo is required to make milestone and royalty payments to the Company. The milestone payments include:
| ● | a payment of $500,000 upon the initiation of the first phase 2 clinical trial for each compound in each of three operating company territories covered by the license: North, Central and South America (including the Caribbean); Asia and the rest of the world; and |
| ● | a payment of $1.0 million for the first new drug application (“NDA”) filing or comparable foreign regulatory filing for each compound in each of the same operating company territories. |
Upon payment of the above milestones, no further payments will be required either for new indications or formulations or for further regulatory filings for the same compound in additional countries within the same territory. In addition, Sucampo is required to pay the Company 5% of any upfront or milestone payments that are received from sublicensees. In February 2009, the Company and Sucampo entered into an addendum to this agreement whereby the patent and know-how royalties payable by Sucampo Pharma Ltd., (“Sucampo Japan”), a wholly-owned subsidiary of Sucampo, to the Company were reduced with respect to sales of lubiprostone in Sucampo territory. During the nine month period ended September 30, 2009 and year ended December 31, 2009, Sucampo paid SAG $500,000 upon its receipt of a $10 million upfront payment from a sublicensee and $375,000 upon its receipt of a $7.5 million development milestone payment from a sublicensee upon the initiation of the phase 3 clinical trial for lubiprostone for the treatment of chronic idiopathic constipation (“CIC”) in Japan.
During the nine months ended September 30, 2010, the submission of Sucampo’s Japanese marketing application for lubiprostone with a dosage strength of 24 micrograms for the indication of CIC triggered an obligation for Sucampo to make a $1.0 million payment to the Company, which was paid in October 2010. Sucampo also was obligated to make payments in the amount of $250,000 to the Company reflecting 5% of the $5.0 million development payment Sucampo earned upon the submission of the marketing application.
Notes Receivable, Related Parties
During the nine months ended September 30, 2010, the Company issued two notes receivable to parties related to the owners of the Company. A 55¥ million note receivable at 1% with a term of one year was issued to a company controlled by the owners of the Company. A 10¥ million note receivable at 1% with a term of five years was issued to a relative of the owners of the Company. The outstanding balances of both notes receivable were paid in full subsequent to September 30, 2010.
4. Intangible Asset
In April 2005, the Company acquired intellectual property related to the Company’s prostone technology from an unrelated party for approximately $272,000, which is capitalized and presented as intangible asset, net in the consolidated balance sheet. The intellectual property will expire in 2022, which is the end of its estimated useful life.
SUCAMPO AG
Notes to Consolidated Financial Statements
The following table displays the changes to the intangible asset for the nine months ended September 30, 2010 and December 31, 2009:
| | | Nine Months Ended September 30, 2010 | | | Year ended December 31, 2009 | |
| | | (unaudited) | | | | |
| Beginning balance: | | | | | | |
| Intangible asset | | $ | 313,173 | | | $ | 307,806 | |
| Accumulated amortization | | | (92,061 | ) | | | (72,425 | ) |
| Carrying balance | | | 221,112 | | | | 235,381 | |
| | | | | | | | | |
| Amortization expense | | | (14,255 | ) | | | (18,264 | ) |
| Foreign currency effect | | | 13,535 | | | | 3,995 | |
| Total activity for period | | | (720 | ) | | | (14,269 | ) |
Ending balance: | | | | | | | | |
| Intangible asset | | | 333,045 | | | | 313,173 | |
| Accumulated amortization | | | (112,653 | ) | | | (92,061 | ) |
| Carrying balance | | $ | 220,392 | | | $ | 221,112 | |
