UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

 

Commission File Number: 001-33609

 

SUCAMPO PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

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 o     No þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Please see definition of “accelerated and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o  Accelerated Filer o   Non-Accelerated Filer þ

 

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

 

As of August 21, 2007, there were 15,538,518 shares of the registrant’s class A common stock outstanding and 26,191,050 shares of the registrant’s class B common stock outstanding.

 

 

Sucampo Pharmaceuticals, Inc.

 

Form 10-Q Index

 

 

SUCAMPO PHARMACEUTICALS, INC.

 

Condensed Consolidated Balance Sheets

(In thousands, except share data)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

SUCAMPO PHARMACEUTICALS, INC.

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Unaudited)

(In thousands, except per share data)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Condensed Consolidated Statements of Changes in Stockholders’ Equity

(In thousands, except share data)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Condensed Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

Description of the Business

 

Sucampo Pharmaceuticals, Inc. (SPI), was incorporated in the State of Delaware on December 5, 1996 and is headquartered in Bethesda, Maryland. On May 23, 2006, SPI’s Board of Directors approved a transaction to have SPI acquire the capital stock of its affiliated European and Asian operating companies, Sucampo Pharma Europe, Ltd. (SPE) and Sucampo Pharma, Ltd. (SPL). On September 28, 2006, SPI completed this reorganization transaction and acquired the capital stock of SPE and SPL. The reorganization was accounted for as a merger of companies under common control, and accounted for at historical cost as of the earliest period presented. Hereinafter, SPI, SPE and SPL are referred to collectively as the “Company.” The financial information of these three entities is presented in these condensed consolidated financial statements. The Company is an emerging pharmaceutical company focused on the discovery, development and commercialization of proprietary drugs based on prostone technology.

 

The Company is a member of a group of affiliated companies (Affiliates) in which the Company’s founders and controlling stockholders own directly or indirectly the majority holdings. Currently, one of the Company’s founders is a member of some of the Affiliates’ Boards and serves as the Chief Executive Officer and Chief Scientific Officer of the Company (see Note 9).

 

In January 2006, the Company received marketing approval from the U.S. Food and Drug Administration (FDA) for its first product, AMITIZA^® (lubiprostone), to treat chronic idiopathic constipation (Constipation) in adults. Commercialization of AMITIZA began in April 2006 throughout the United States.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles and the rules and regulations of the Securities and Exchange Commission, or SEC, for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Company’s consolidated financial statements as of and for the year ended December 31, 2006 included in the Company’s Registration Statement on Form S-1, as amended (Registration No. 333-135133), which was declared effective by the SEC on August 2, 2007. The financial information as of June 30, 2007 and for the three and six months ended June 30, 2007 and June 30, 2006 is unaudited. In the opinion of management, all adjustments, consisting only of normal recurring adjustments or accruals, considered necessary for a fair statement of the results of these interim periods have been included. The results of the Company’s operations for any interim period are not necessarily indicative of the results that may be expected for any other interim period or for a full fiscal year.

 

The condensed consolidated financial statements include the accounts of SPI and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated.

 

Initial Public Offering

 

In August 2007, the Company consummated its initial public offering, consisting of 3,125,000 shares of class A common stock sold by the Company and 625,000 shares sold by a stockholder of the Company, at a public offering price of $11.50 per share, resulting in net proceeds to the Company of approximately $28.4 million (after deducting payment of underwriters discounts, commissions, and expenses of the offering). In connection with the initial public offering, the Company implemented an 8.5-to-one stock split of the Company’s common stock in the form of a stock dividend. This stock dividend was effective July 12, 2007. All historical common stock and per share common stock information has been retroactively restated to reflect this stock split. Preferred stock information has not been changed except to reflect the modification of the conversion ratio to 850-to-one, after giving effect to this stock split. In connection with this stock split, the Company amended its certificate of

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

incorporation to increase the authorized number of shares of class A common stock to 75,000,000 and the authorized number of shares of class B common stock to 75,000,000. Upon consummation of the initial public offering, all shares of the Company’s series A Preferred Stock were converted into an aggregate of 3,213,000 shares of class A common stock.

 

Capital Resources

 

The Company has a limited operating history and its expected activities will necessitate significant uses of working capital throughout 2007 and beyond. The Company’s capital requirements will depend on many factors, including the successful sales of AMITIZA, research and development efforts to develop new products, payments received under contractual agreements with other parties, the status of competitive products and market acceptance of the Company’s new products by physicians and patients. The Company plans to continue financing operations in part with cash received from its initial public offering and from its joint collaboration and license agreement and the supplemental agreement entered into with Takeda Pharmaceutical Company Limited (Takeda) (see Note 10).

 

 

The Company has restated its previously issued condensed consolidated financial statements and related footnotes for the six months ended June 30, 2006, as set forth in these condensed consolidated financial statements. The Company has restated its condensed consolidated financial statements to correct an error in accounting for the revenue recognition of the collaboration and license agreements with Takeda. All amounts in these condensed consolidated financial statements have been updated to reflect this restatement.

 

Description of Errors

 

The Company identified an error at its operating company in the United States. This error originated in the fourth quarter of 2004 and continued throughout 2005 and part of 2006. The identification of this error occurred as a result of the Company evaluating its assumptions under Emerging Issues Task Force (EITF) No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21), in accounting for arrangements with multiple deliverables that require significant judgment and estimates.

 

The Company reassessed whether each of its required deliverables under the 16-year joint collaboration and license agreement with Takeda (Takeda Agreement), which was executed in October 2004, had value to Takeda on a stand-alone basis and whether there is objective and reliable evidence of the fair value of each of those deliverables. This reassessment determined that the previous assessment of a single unit of accounting for the deliverables under the Takeda Agreement was not appropriate. In addition, the Company determined that the substantive milestone method was not appropriate to account for the cash payments received from Takeda related to the Company completing these required deliverables and a time-based model would be more appropriate to account for such cash payments from Takeda. Accordingly, in the restated condensed consolidated financial statements for the six months ended June 30, 2006, the Company reduced the milestone revenue and increased research and development revenue. As a result, total revenues increased by approximately $4.9 million for the six months ended June 30, 2006.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

The following table presents the effects of the restatement adjustments on the affected line items in the previously reported condensed consolidated statements of operations and comprehensive income for the six months ended June 30, 2006. The restatement adjustments did not affect the overall cash (used in) provided by operating, investing or financing activities or the effect of exchange rates on cash and cash equivalents in the condensed consolidated statements of cash flows for six months ended June 30, 2006.

 

Impact on Condensed Consolidated Statement of Operations and Comprehensive Income Items

 

 

 

Cash and Cash Equivalents

 

For the purpose of the condensed consolidated balance sheets and statements of cash flows, cash equivalents include all highly liquid investments with an original maturity date or remaining maturity date at time of purchase of three months or less.

 

Restricted Cash

 

Restricted cash consists of approximately $218,000 and $213,000 at June 30, 2007 and December 31, 2006, respectively, of cash securing a letter of credit related to the Company’s new headquarters lease agreement dated December 18, 2006 (see Note 7). This letter of credit renews automatically each year and is required until the lease expires on February 15, 2017.

 

Short-term Investments

 

Short-term investments consist entirely of auction rate securities and a money market account. The Company’s investments in these securities are classified as available-for-sale securities under Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (SFAS 115). Although the auction rate securities have variable interest rates which typically reset every 7 to 35 days, they have long-term contractual maturities, spanning from September 1, 2024 to April 1, 2040, which is why they are not classified as cash equivalents. These investments are classified within current assets because the Company has the

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

ability and the intent to liquidate these securities if needed within a short-term time period. These available-for-sale securities are accounted for at fair market value and unrealized gains and losses on these securities, if any, are included in accumulated other comprehensive loss in stockholders’ equity. Interest and dividend income is recorded when earned and included in interest income. Premiums and discounts, if any, on short-term investments are amortized or accreted to maturity and included in interest income. The Company uses the specific identification method in computing realized gains and losses on sale of short-term investments.

 

Fair Value of Financial Instruments

 

The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, restricted cash, short-term investments, accounts receivable, accounts payable and accrued liabilities, approximate their fair values due to their short maturities.

 

Accounts Receivable

 

Accounts receivable include amounts due under the joint collaboration and licensing agreement with Takeda (see Note 10). The Company did not record an allowance for doubtful accounts at June 30, 2007 or at December 31, 2006 because it believes that its accounts receivable are fully collectible and it does not have a history of credit losses or write-offs of its accounts receivable.

 

Property and Equipment

 

Property and equipment are recorded at cost and consist of computer and office machines, furniture and fixtures and leasehold improvements. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. Computer and office machines are depreciated over four years and furniture and fixtures are depreciated over seven years. Leasehold improvements are amortized over the shorter of five years or the life of the lease. 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.

 

Prepaid Expenses and Other Current Assets

 

Prepaid expenses and other current assets include capitalized costs incurred for the Company’s initial public offering, which was recorded as a current asset because the initial public offering was completed within twelve months from June 30, 2007. As of June 30, 2007, the Company had incurred capitalized costs of $4.0 million associated with its initial public offering. Upon completion of the initial public offering, the capitalized initial public offering costs will be reclassified to “Additional paid-in capital” to offset the proceeds from the initial public offering.

 

As of December 31, 2006, the capitalized costs of $3.1 million associated with the Company’s initial public offering, which was recorded as a current asset because the initial public offering was completed within twelve months from June 30, 2007, were classified as deposits and other assets. At December 31, 2006, the Company was uncertain of when the initial public offering would be completed.

 

Revenue Recognition

 

Collaboration and License Agreements

 

The Company’s primary sources of revenue include up-front payments, development milestone payments, reimbursements of development and co-promotion costs and royalties. The Company recognizes revenue from these sources in accordance with Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition” (SAB 104), EITF No. 99-19, “Reporting Revenue Gross as a Principal Versus Net as an Agent” (EITF 99-19), and EITF No. 00-21. The application of EITF 00-21 requires subjective analysis and requires management to make estimates

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

and assumptions about whether deliverables within multiple-element arrangements are separate units of accounting and to determine the fair value to be allocated to each unit of accounting.

 

The Company’s deliverables under the Takeda Agreement and the supplemental agreement, which was executed in February 2006, (Supplemental Agreement), including the related rights and obligations, contractual cash flows and performance periods, are more fully described in Note 10.

 

The Takeda Agreement provides for the following key funding streams: an up-front payment, product development milestone payments, reimbursements of development costs and product royalty payments. The cash flows associated with the individual units of accounting from the Takeda Agreement are recognized as revenue using a time-based model. Under this model, cash flow streams related to each unit of accounting are recognized as revenue over the estimated performance period. Upon receipt of cash payments, revenue is recognized to the extent the accumulated service time, if any, has occurred. The remainder is deferred and recognized as revenue ratably over the remaining estimated performance period. A change in the period of time expected to complete the deliverable is accounted for as a change in estimate on a prospective basis. Revenue is limited to amounts that are nonrefundable and that Takeda is contractually obligated to pay to the Company.

 

Based on the guidance of EITF 99-19, the Company has determined that it is acting as a principal under the Takeda Agreement and, as such, records these amounts as collaboration revenue and research and development revenue.

 

Royalties from licensees are based on third-party sales of licensed products and are recorded on the accrual basis when earned in accordance with contractual terms when third-party results are reliably measurable, collectability is reasonably assured and all other revenue recognition criteria are met. Because of the lack of historical data regarding sales returns, royalty payments related to the portion of sales by Takeda that are subject to a right of return are not reported as revenue until the period of right of return lapses.

 

Reimbursements of co-promotion costs for the Company’s sales force efforts and reimbursements of miscellaneous marketing costs under the Supplemental Agreement are recognized as revenue as the related costs are incurred and Takeda becomes contractually obligated to pay the amounts. Based on the guidance of EITF 99-19, the Company has determined that it is acting as a principal as it relates to these activities under the Supplemental Agreement and, as such, records reimbursements of these amounts as co-promotion revenue.

 

Deferred Revenue

 

Consistent with the Company’s policy on revenue recognition, deferred revenue represents cash received in advance for licensing fees, consulting, research and development contracts and related cost sharing and supply agreements. Such payments are reflected as deferred revenue until revenue can be recognized under the Company’s revenue recognition policy. Deferred revenue is classified as current if management believes the Company will be able to recognize the deferred amount as revenue within 12 months of the balance sheet date. At June 30, 2007 and December 31, 2006, total deferred revenue was approximately $9.5 million and $20.7 million, respectively.

 

Total deferred revenue consists of the following as of:

 

 

Research and Development Expenses

 

Research and development costs are expensed in the period in which they are incurred and include the expenses to third parties who conduct research and development activities pursuant to development and consulting agreements on behalf of the Company. Costs related to the acquisition of intellectual property are expensed as

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

incurred since the underlying technology associated with such acquisitions were made in connection with the Company’s research and development efforts and the technology is unproven and had not received regulatory approval at its early stage of development. Milestone payments due under agreements with third-party contract research organizations (CROs) are accrued when it is deemed probable that the milestone event will be achieved.

 

General and Administrative Expenses

 

General and administrative costs are expensed as incurred and consist primarily of salaries and other related costs for personnel serving executive, finance, accounting, information technology and human resource functions. Other costs include facility costs and professional fees for legal and accounting services.

 

Reimbursement of the Company’s safety costs is recorded as a reduction of safety expenses and is included in general and administrative expenses. The Company has determined, in accordance with EITF 99-19, that it is acting as an agent in this arrangement and, as such, records reimbursements of these expenses on a net basis, offsetting the underlying expenses.

 

Selling and Marketing Expenses

 

Selling and marketing expenses are expensed as incurred and consist primarily of salaries and related costs for personnel, sales force fees and certain marketing expenditures.

 

Milestone Royalties — Related Parties

 

Milestone royalties — related parties are expensed as incurred immediately when the related milestone payments are due from Takeda. The milestone royalty is 5% of milestone payments received under any sublicensing agreements for AMITIZA. In addition, for each indication for AMITIZA for which there is regulatory approval, the Company must pay a $250,000 milestone. The milestone royalties are to be paid to Sucampo AG (SAG), (Switzerland), affiliated through common ownership. The Company expensed $1.5 million in royalties for the three months ended June 30, 2007 and did not incur such expenses during the three months ended June 30, 2006. For the six months ended June 30, 2007 and 2006, the Company expensed $1.5 million and $1.25 million in royalties, respectively. The Company has recorded a corresponding liability of $1.5 million and $0 as “Accrued expenses” as of June 30, 2007 and December 31, 2006, respectively.

 

Product Royalties — Related Parties

 

Product royalties — related parties represent the Company’s obligation to SAG for 3.2% of net sales for AMITIZA and are expensed as incurred. The Company expensed approximately $1.7 million and $1.0 million in product royalties for the three months ended June 30, 2007 and 2006, respectively. For the six months ended June 30, 2007 and 2006, the Company expensed approximately $2.1 million and $1.0 million in product royalties, respectively. The Company has recorded a corresponding liability of approximately $1.7 million and $361,000 as “Accrued expenses” as of June 30, 2007 and December 31, 2006, respectively.

 

Employee Stock-Based Compensation

 

The Company accounts for employee stock-based compensation expenses in accordance with the fair value recognition provisions of SFAS No. 123R, “Share-Based Payment” (SFAS 123R), which requires the measurement and recognition of compensation expense for all share-based payments made to employees and directors be based on estimated fair values.

 

As employee stock-based compensation expense recognized in the condensed consolidated statements of operations for the three and six months ended June 30, 2007 and 2006 is based upon awards expected to ultimately vest, it has been reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

The Company recognizes employee stock-based compensation expense under SFAS 123R for its fixed awards with pro-rata vesting based on a straight-line basis.

 

The employee stock-based compensation expense under SFAS 123R recorded in the Company’s condensed consolidated statements of operations and comprehensive income for three and six months ended June 30, 2007 and 2006 was as follows:

 

 

The Company recorded a cumulative out-of-period adjustment of approximately $358,000 during the six months ended June 30, 2007 to reduce an overstatement of additional paid-in capital and general and administrative expenses that had been recorded as of and for the year ended December 31, 2006 in connection with certain employee stock options awarded in 2006. The error resulted from applying the incorrect contractual term for certain employee stock options. The impacts of this adjustment were not material to the consolidated financial statements for the year ended December 31, 2006, for the corresponding interim periods or for the period in which it was recorded, as the adjustment consisted of insignificant amounts related to each of the quarterly reporting periods dating back to the quarter ended June 30, 2006.

 

Income Taxes

 

The Company accounts for income taxes under the liability method in accordance with provisions of SFAS No. 109, “Accounting for Income Taxes” (SFAS 109), which requires companies to account for deferred income taxes using the asset and liability method. Under the asset and liability method, 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 income during the period such changes are enacted. Changes in ownership may limit the amount of net operating loss carryforwards that can be utilized in the future to offset taxable income.

 

The Company accounts for its interim tax provision using Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Reporting” (APB 28). Under APB 28, the interim tax provision is calculated based on the Company’s projected annual effective tax rate.

 

Accounting for the Uncertainty of Income Taxes

 

On January 1, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. The adoption of FIN 48 did not have an impact on the Company’s financial statements.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

The Company conducts business in the U.S., Japan and the United Kingdom and is subject to those jurisdictions. As a result of its business activities, the Company files tax returns that are subject to examination by the respective federal, state, local and foreign tax authorities. For income tax returns filed by the Company, the Company is no longer subject to U.S. federal, state and local, or foreign income tax examination by tax authorities for years before 2003, although carryforward tax attributes that were generated prior to 2003 may still be adjusted upon examination by tax authorities if they either have been or will be utilized. The Company has not received any communications by taxing authorities that cause it to believe it is currently under examination by the tax authorities in any of the jurisdictions in which it operates.

 

The Company recognizes interest and penalties accrued related to unrecognized tax benefits as a component of tax expense. For the three and six months ended June 30, 2007, there have been no interest and penalties accrued.

 

Certain Risks, Concentrations and Uncertainties

 

The Company’s product candidates under development require approval from the FDA or other international regulatory agencies prior to commercial sales. For those product candidates that have not been approved by the FDA, there can be no assurance the products will receive the necessary approval. If the Company is denied approval or approval is delayed, it may have a material adverse impact on the Company.

 

The Company’s product is concentrated in a rapidly changing, highly competitive market, which is characterized by advances in scientific discovery, changes in customer requirements, evolving regulatory requirements and industry standards. Any failure by the Company to anticipate or to respond adequately to scientific developments in its industry, changes in customer requirements or changes in regulatory requirements or industry standards, or any significant delays in the development or introduction of products or services could have a material adverse effect on the Company’s business, operating results and future cash flows.

 

Revenues from one unrelated party, Takeda, accounted for 100%, 99%, 100% and 100% of the Company’s total revenues for the three months ended June 30, 2007 and 2006 and the six months ended June 30, 2007 and 2006, respectively. Accounts receivable from one unrelated party, Takeda, accounted for $42.3 million (99%) and $2.7 million (75%) of the Company’s accounts receivable at June 30, 2007 and December 31, 2006, respectively.

 

Segment Information

 

Management has determined that the Company has three reportable segments, which are based on its method of internal reporting, which disaggregates its business by geographical location. The Company’s reportable segments are the United States, Europe and Japan (see Note 13).

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

 

Recent Accounting Pronouncements

 

In February 2007, the FASB Staff issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159), which provides entities with the opportunity to measure certain financial instruments at fair value. The Company will be required to adopt SFAS 159 for the year beginning January 1, 2008. The Company is assessing SFAS 159 and its impact on the Company’s future consolidated financial statements.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

In June 2007, the Emerging Issues Task Force issued EITF No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (EITF 07-3), which provides guidance to research and development companies on how to account for the nonrefundable portion of an advance payment made for research and development activities. The Company will be required to adopt EITF 07-3 for the year beginning after December 15, 2007. The Company is currently assessing EITF 07-3 and does not expect a material impact on its future condensed consolidated financial statements upon its adoption.

 

 

Historical

 

Basic net income per share is computed by dividing net income by the sum of the weighted average class A and B common shares outstanding. Diluted net income per share is computed by dividing net income by the weighted average common shares and potential dilutive common shares outstanding.

 

Computation of Earnings per Share

 

The computation of historical net income per share for the three and six months ended June 30, 2007 and 2006 is shown below:

 

 

The potentially dilutive securities used in the calculations of diluted historical net income per share for the three and six months ended June 30, 2007 and 2006 are as follows:

 

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

 

Property and equipment consists of the following as of:

 

 

Depreciation and amortization expense for the three months ended June 30, 2007 and 2006 was $36,000 and $18,000, respectively, and for the six months ended June 30, 2007 and 2006 was $60,000 and $34,000, respectively.

 

 

Accrued expenses consist of the following as of:

 

 

 

Operating Leases

 

The Company leases office space in the United States, United Kingdom and Japan under operating leases through 2017. The leases require the Company to make certain non-cancelable lease payments until expiration. Total future minimum lease payments under operating leases are $10.3 million as of June 30, 2007.

 

Rent expense for all operating leases was approximately $297,000 and $134,000 for the three months ended June 30, 2007 and 2006, respectively, and approximately $464,000 and $266,000 for the six months ended June 30, 2007 and 2006, respectively.

 

Research and Development Costs

 

The Company routinely enters into several agreements with third-party CROs to oversee clinical research and development studies provided on an outsourced basis. The Company is not generally contractually obligated to pay the CRO if the service or reports are not provided. Total future estimated costs under these agreements as of June 30, 2007 are $3.9 million.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

 

On June 19, 2007, the Compensation Committee of the Company’s Board of Directors authorized a one-time stock and cash award to each of the Company’s founders. These awards were granted on June 29, 2007 when the founders agreed to their terms, but were not to be settled until the earlier of the completion of the initial public offering or December 31, 2007. In August 2007, the awards were settled upon the completion of the initial public offering. The Compensation Committee intended for these awards to compensate the founders for the lost value of stock options that had been granted to them in 2001 and 2002 and had been understood by them to have ten-year terms, but which had expired in 2006 and early 2007 as a result of the terms of the 2001 Stock Incentive Plan. The expired options would have entitled the founders to purchase an aggregate of 578,000 shares of class A common stock at a price of $0.21 per share and 136,000 shares at a price of $2.95 per share. These awards were fully vested at the grant date.

 

Upon the completion of the initial public offering, these stock and cash awards had an aggregate value equal to the difference between the value of the shares that could have been purchased under each of the expired options, determined on the basis of the public offering price per share of $11.50 in the initial public offering, and the respective aggregate exercise prices for such shares as provided in the option agreements.

 

These awards consisted of a combination of cash and shares of class A common stock. Of the aggregate value of each award, 40% was payable in cash and 60% in stock. For purposes of determining the number of shares of class A common stock to be issued in connection with each award, the stock was valued on the basis of the public offering price per share in the initial public offering.

 

The estimated fair value of these awards was based on using the Black-Scholes pricing model, as allowed under SFAS 123R, totaling $10.2 million on grant date. For the three and six months ended June 30, 2007, the Company recorded $10.2 million of general and administrative expense for these awards, of which $4.1 million was recorded as “Other liabilities — related parties” for the cash settlement portion and $6.1 million as “Additional paid-in capital” for the stock settlement portion. The liability portion of the awards will be adjusted based upon the final cash settlement amount, but the equity portion is fixed upon the grant date.

 

When the initial public offering was completed subsequent to June 30, 2007, the awards were settled and 401,133 shares of class A common stock were issued to the founders. In addition, the Company recorded an adjustment to finalize the liability portion of the awards to reduce the liability to $3.1 million, which will be the amount paid to the founders.

 

 

On March 7, 2003, the Company entered into an exclusive supply agreement with R-Tech Ueno, Ltd. (RTU), affiliated through common ownership. The agreement grants RTU the exclusive right to manufacture and supply RUG-015, a prostone compound, and lubiprostone, and in consideration for such right RTU agreed to pay the Company as follows: $1.0 million upon execution of the agreement, $2.0 million upon commencement of a first Phase II lubiprostone trial, $3.0 million upon commencement of a first Phase II RUG-015 trial and $2.0 million upon commencement of the earlier of a second Phase II or a first Phase III RUG-015 trial. Upon execution of the agreement, the Company had already commenced Phase II clinical trials for RUG-015 and lubiprostone, which resulted in an immediate payment of $6.0 million — $1.0 million for the agreement execution, $2.0 million for the commencement of the first Phase II lubiprostone trial, and $3.0 million for the commencement of the first phase II RUG-015 trial. The Company evaluated the $6.0 million in cash receipts from RTU and determined the payments were made for the exclusive right to supply inventory to the Company and determined that the amounts should be deferred until commercialization of the drugs begins since this is the point at which the underlying services would commence. Management also was unable to adequately assign value between the two compounds based on the information available to the Company and determined that the full $6.0 million deferred amount would be

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

amortized over the contractual life of the relationship which was equivalent to the estimated commercialization periods of both RUG-015 and lubiprostone (estimated to be through December 2020).

 

During the year ended December 31, 2005, the Company ceased the development of RUG-015 due to less than satisfactory Phase II results and the Company’s Board of Directors approved the Company’s decision to discontinue the development of RUG-015. In addition to the Company’s Board of Directors, RTU also formally approved the abandonment of RUG-015, which was a requirement in the supply agreement terms. Because the Company was unable to assign value to the compounds at the time the agreement was executed and the $6.0 million was received from RTU, the full $6.0 million remained deferred at the abandonment of RUG-015.

 

The abandonment of RUG-015 changed the amortization period of the $6.0 million deferred revenue to the commercialization period of lubiprostone (AMITIZA), which began April 2006. The Company has recognized revenue of approximately $105,000 for the three months ended June 30, 2007 and 2006 and approximately $209,000 and $105,000 for the six months ended June 30, 2007 and 2006, respectively, which is recorded as contract revenue — related party.

 

On June 24, 2005, the Company entered into a 20-year exclusive manufacturing and supply agreement with RTU, affiliated through common ownership. The agreement grants RTU the exclusive right to manufacture and supply lubiprostone for clinical and commercial supplies within Europe. In consideration of the exclusive rights, RTU paid the Company $2.0 million prior to the execution of the agreement on March 31, 2005. Management has determined that the amount should be deferred until such time as the commercial benefit to RTU can be realized. As lubiprostone has not been approved within Europe, the $2.0 million has been recorded as non-current deferred revenue as of June 30, 2007 and December 31, 2006.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

 

The following table summarizes the cash streams and related revenue recognition under the Takeda Agreement and the Supplemental Agreement, which are described in more detail below:

 

 

 

 

On October 29, 2004, the Company entered into the Takeda Agreement to exclusively co-develop, commercialize and sell products that contain lubiprostone for gastroenterology indications in the United States and Canada. Payments to the Company under the Takeda Agreement include a non-refundable up-front payment, non-refundable development and commercial milestone payments, reimbursement of certain development and co-promotion costs and royalties.

 

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

 

 

As a result of its reassessment of the deliverables under the Takeda Agreement (see Note 2), the Company determined there were four separate units of accounting as of the inception of the Takeda Agreement. The Company has assessed these required deliverables under the guidance of EITF 00-21 to determine which deliverables are considered separate units of accounting. The Company determined that its participation in the Joint Steering Committee, the Joint Manufacturing Committee and the Joint Commercialization Committee has value to Takeda on a stand-alone basis because the individual committee participants provided by the Company have valuable expertise that the Company believes support the success of the Takeda Agreement. Takeda could have obtained similar expertise by hiring independent consultants, but is relying instead on the expertise of the Company.

 

The Company was also able to determine objective and reliable evidence of the fair value of these deliverables, including anticipated expenses expected to be incurred to meet its obligations, in the form of contract agreements between the Company and specialized consultants for other development projects the Company is and has been involved with currently and in the past. The Company was not, however, able to distinguish stand-alone value for participation in the Joint Development Committee separate from the Company’s obligations to perform development work of Constipation and IBS-C because the participation in the Joint Development Committee was to occur concurrently with the development work. Thus, the Company has determined that there were four separate units of accounting when the Takeda Agreement was executed — (1) participation in the Joint Steering Committee, (2) participation in the Joint Manufacturing Committee, (3) participation in the Joint Commercialization Committee and (4) the combined requirement of the development work of Constipation and IBS-C and participation in the Joint Development Committee.

 

Upon receipt of the $20.0 million up-front payment, the Company deferred approximately $2.4 million to be recognized using the time-based model over the performance period of the participation in these meetings. During the three months ended June 30, 2007 and 2006, the Company recognized approximately $37,000 of this deferred amount as collaboration revenue on the condensed consolidated statements of operations and comprehensive income and $74,000 of this deferred amount as collaboration revenue during the six months ended June 30, 2007 and 2006. The related deferred revenue as of June 30, 2007 was approximately $2.0 million.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

Since the execution of the Takeda Agreement through December 31, 2006, the Company deferred the residual amount of the $20.0 million up-front payment totaling approximately $17.6 million, development milestone payments received totaling $50.0 million, and reimbursement of the initial $30.0 million of research and development costs for the development of AMITIZA for Constipation and IBS-C indications. These deferred amounts were applied towards the unit of accounting combining the participation in the Joint Development Committee and the development of Constipation and IBS-C and are being recognized using the time-based model over the performance period of developing the Constipation and IBS-C NDA submissions. The Company had originally estimated that it would complete the development of the Constipation and IBS-C NDA submissions in December 2006. The Company concluded in June 2006 that the estimated completion date should be revised to May 2007. Subsequent to December 31, 2006, the Company further extended the estimated completion date from May 2007 to June 2007. During the three months ended June 30, 2007 and 2006, the Company recognized approximately $4.9 million and $9.7 million, respectively, of these deferred amounts as research and development revenue in the condensed consolidated statements of operations and comprehensive income. During the six months ended June 30, 2007 and 2006, the Company recognized approximately $11.0 million and $31.7 million, respectively, of these deferred amounts as research and development revenue in the condensed consolidated statements of operations and comprehensive income. There was no related deferred revenue as of June 30, 2007. In June 2007, the Company recognized, in full, $30.0 million from Takeda upon the filing of the supplemental NDA for AMITIZA to treat irritable bowel syndrome with constipation as the Company had completed its development.

 

The Company incurred research and development costs for this development work of approximately $1.9 million, $2.0 million, $12.9 million and $4.9 million for the three months ended June 30, 2007 and 2006 and for the six months ended June 30, 2007 and 2006, respectively.

 

On February 1, 2006, the Company entered into the Supplemental Agreement with Takeda, which amends the responsibilities of both the Company and Takeda for the co-promotion of AMITIZA and clarifies the responsibilities and funding arrangements for other marketing services to be performed by both parties.

 

Upon execution of the Supplemental Agreement, the Company was required to complete several deliverables,which Takeda was responsible to fund. The following are the required deliverables of the Company, along with the related contractual cash flows from Takeda and the associated obligations and performance period of the Company, when the Supplemental Agreement was executed:

 

 

The Company has determined that the required deliverables under the Supplemental Agreement are economically independent of those in the original Takeda Agreement. The Company had no obligations to perform any

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

of the deliverables under the Supplemental Agreement at the time the original Takeda Agreement was executed and the activities were not considered to be, or contemplated as, deliverables at that time. Subsequent to the execution of the original Takeda Agreement, the Company agreed to perform co-promotion and other marketing services for a fee that was negotiated at the time of the Supplemental Agreement. The negotiated rates were determined to be market compensation for services agreed to in the Supplemental Agreement based upon the stand-alone value of the economics of the new obligations. Therefore, the Company views the deliverables under the Supplemental Agreement as economically independent of those in the original Takeda Agreement.

 

The Company has assessed these required deliverables under the guidance of EITF 00-21 to determine which deliverables are considered separate units of accounting. The Company was able to determine that its sales force has value to Takeda on a stand-alone basis because the Company provided coverage in a market segment which could increase the sales of AMITIZA. In negotiating the Supplemental Agreement, the Company established the fair value for the per-day co-promotion rate using third-party evidence from contract sales organizations. The Company has also determined that the miscellaneous marketing activities have stand-alone value to Takeda separate from the Company’s efforts to perform its obligations to implement and maintain its sales force. These miscellaneous marketing services, which related primarily to documenting and publicizing the medical benefits of the product, could have been outsourced directly to a number of different third parties (as the Company ultimately did), performed by Takeda staff or eliminated entirely if not judged to have a benefit which exceeded the related costs. Accordingly, these deliverables are treated as separate units of accounting. The Company is recognizing the cost reimbursements received for these deliverables as co-promotion revenues when services are performed and the reimbursement payments are due under the Supplemental Agreement. For the three months ended June 30, 2007 and 2006 and for the six months ended June 30, 2007 and 2006, the Company recognized approximately $1.1 million, $1.1 million, $2.1 million and $1.1 million, respectively, of co-promotion revenue for its sales force efforts and approximately $0, $161,000, $158,000 and $162,000, respectively, for its miscellaneous marketing efforts.

 

During the quarter ended June 30, 2006, the Joint Commercialization Committee granted approval for the Company and Takeda to begin three new studies related to funding arrangements discussed in both the Takeda Agreement and the Supplemental Agreement. The following are the three additional deliverables of the Company, along with the related contractual cash flows from Takeda and the associated obligations and performance period of the Company, when the three studies were agreed upon:

 

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

 

The Company has assessed these required deliverables under the guidance of EITF 00-21 to determine which deliverables are considered separate units of accounting. As a result of the Company and Takeda agreeing to perform and fund these studies simultaneously, the Company determined that there is no objective and reliable evidence to determine the fair value for each of the studies. Accordingly, the Company has combined these three required deliverables as a single unit of accounting. All cash payments from Takeda related to these three deliverables will be deferred upon receipt and recognized over the entire period to complete the three studies using the time-based model. The estimated completion date is June 2009. During the three months ended June 30, 2007 and 2006 and the six months ended June 30, 2007 and 2006, the Company recognized approximately $3.0 million, $0 million, $6.4 million and $0 million related to these three deliverables as research and development revenue on the condensed consolidated statements of operations and comprehensive income, respectively.

 

 

A summary of the activity under the Company’s 2001 Stock Incentive Plan is presented below for the six months ended June 30, 2007:

 

 

As of June 30, 2007, approximately $564,000 of total unrecognized compensation costs, net of estimated forfeitures, related to non-vested awards are expected to be recognized over a weighted average period of 4.73 years.

 

 

For the three months ended June 30, 2007 and 2006, the Company’s consolidated annualized effective tax rate was 35.0% and 0%, respectively. For the six months ended June 30, 2007 and 2006, the Company’s consolidated annualized effective tax rate was 35.2% and 0%, respectively. As required under Accounting Principles Board Opinion No. 28, “Interim Financial Reporting”, the Company has estimated its annual effective tax rate for the full fiscal year 2007 and applied that rate to its income before income taxes in determining its income tax provision for the interim periods.

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

 

The Company has determined that it has three reportable geographic segments based on the Company’s method of internal reporting, which disaggregates business by geographic location. These segments are the United States, Europe and Japan. The Company evaluates performance of these segments based on income from operations. The reportable segments have historically derived their revenue from joint collaboration and strategic alliance agreements. Transactions between the segments consist primarily of loans and the provision of research and development services by the European and Japanese entities to the domestic entity. Following is a summary of financial information by reportable geographic segment.

 

 

SUCAMPO PHARMACEUTICALS, INC.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)