Business Combination

12 Months Ended

Dec. 31, 2013

Business Combination

Business Combination

G.    Business Combination

        As part of our strategy to expand our portfolio with additional commercial-stage specialty products, in June 2013, we entered into the Access License Agreement pursuant to which we obtained an exclusive, royalty-bearing license, with the right to grant sublicenses, to certain intellectual property rights, including know-how, patents and trademarks, to use, import, offer for sale, sell, manufacture and commercialize MuGard in the U.S. Territory for the management of all diseases or conditions of the oropharyngeal cavity, including mucositis.

MuGard was launched in the U.S. by Access in 2010 after receiving 510(k) clearance from the FDA and is indicated for the management of oral mucositis/stomatitis (that may be caused by radiotherapy and/or chemotherapy) and all types of oral wounds (mouth sores and injuries), including aphthous ulcers/canker sores and traumatic ulcers, such as those caused by oral surgery or ill-fitting dentures or braces.

        Access remains responsible for the manufacture of MuGard and we have entered into a quality agreement and plan to enter into a supply agreement with Access under which we will purchase MuGard inventory from Access. Our inventory purchases are at the price actually paid by Access to purchase it from a third-party plus a mark-up to cover administration, handling and overhead.

        In consideration for the license, we paid Access an upfront payment of $3.3 million in June 2013. We are required to pay royalties to Access on net sales of MuGard until the later of (a) the expiration of the licensed patents or (b) the tenth anniversary of the first commercial sale of MuGard under the Access License Agreement in the U.S. Territory, or the Royalty Term. These tiered, double-digit royalty rates decrease for any part of the Royalty Term occurring after the expiration of the licensed patents and are subject to off-set against certain of our expenses. After the expiration of the Royalty Term, the license shall become a fully paid-up, royalty-free and perpetual license in the U.S. Territory. In addition to making an upfront payment of $3.3 million, we also acquired $0.2 million of existing MuGard inventory from Access, which was included in our condensed consolidated balance sheet as of the Acquisition Date.

        We did not assume any pre-existing liabilities related to the MuGard business, contingent or otherwise, arising prior to the Acquisition Date. We are accounting for the acquisition of the MuGard Rights as a business combination under the acquisition method of accounting since we acquired the U.S. commercial rights for MuGard and inventory, and obtained access to certain related regulatory assets and product supply, employees and other assets, including certain patent and trademark rights, contracts, and related books and records, held by Access which are exclusively related to MuGard (inputs), including the infrastructure to sell, distribute and market MuGard (processes) and net sales of MuGard (outputs). In addition, during the term of the Access License Agreement, we will have control over sales, distribution and marketing of MuGard in the U.S. as Access has assigned to us all of its right, title and interest in MuGard-related internet and social media outlets and other sales, marketing and promotional materials currently owned or controlled by Access. Access will no longer commercialize, market, promote, sell or make public communications relating to MuGard in the U.S Territory, except as may be agreed to by us. Access has also agreed to not, directly or indirectly, research, develop, market, sell or commercialize any medical devices that directly compete with MuGard for the treatment of any diseases or conditions of the oropharyngeal cavity in the U.S. Territory.

        We estimated the fair value of the acquired MuGard Rights using the income approach. The income approach uses valuation techniques to convert future amounts to a single present amount (discounted). This approach begins with a forecast of the net cash flows expected to be generated by the asset over its estimated useful life. These cash flows are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and assumptions inherent in the income approach include the following:

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  The amount and timing of projected future cash flows, adjusted for the probability of marketing success;

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  The discount rate selected to measure the risks inherent in the future cash flows; and

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  An assessment of the asset's life-cycle and the competitive trends impacting the asset.

        The following table summarizes the total consideration for the MuGard Rights (in thousands):

Consideration:
Cash	$	3,434
Acquisition-related contingent consideration		13,700
Total consideration	$	17,134

        The $17.1 million total consideration includes the estimated fair value of the contingent consideration at the Acquisition Date. During 2013, we completed the valuation for the acquisition of the MuGard Rights and determined the fair value of the contingent consideration to be $13.7 million as of the Acquisition Date, and the fair value of the intangible asset was determined to be $16.9 million as of the Acquisition Date. The Acquisition Date fair value of the contingent consideration was determined based on various market factors, including an analysis of estimated sales using a discount rate of approximately 15%. As of December 31, 2013, we estimated that the undiscounted royalty amounts we could pay under the Access License Agreement may range from $28.0 million to $34.0 million over a ten year period, which is our best estimate of the period over which we expect the majority of the asset's cash flows to be derived. The measurement period adjustments represent updates made to the preliminary valuation based on revisions to estimates in the interim period subsequent to the acquisition and initial accounting date.

        The following table summarizes the estimated fair values of the assets acquired related to the business combination as of the Acquisition Date (in thousands):

Assets Acquired:
MuGard intangible asset	$	16,893
Inventory		241
Net identifiable assets acquired	$	17,134

        The Acquisition Date fair value of the intangible asset was determined based on various market factors, including an analysis of estimated sales using a discount rate of 19%. This measure is based on significant Level 3 inputs not observable in the market. Such valuations require significant estimates and assumptions including but not limited to: estimating future cash flows from product sales and developing appropriate discount and probability rates. We believe the estimated fair values of the MuGard Rights are based on reasonable assumptions, however, we cannot provide assurance that the underlying assumptions used to forecast the cash flows will materialize as we estimated and thus, our actual results may vary significantly from the estimated results.

        Commencing from the Acquisition Date, our consolidated financial statements include the assets, liabilities, operating results and cash flows from the acquired product. Revenues related to MuGard sales for 2013 were not material.

        Transaction costs are not included as a component of consideration transferred and are expensed as incurred. We incurred approximately $0.8 million of acquisition-related costs in 2013. These costs were primarily related to professional and legal fees and are included in selling, general and administrative expenses in our consolidated statements of operations for 2013.

        Pro forma results of operations would not be materially different as a result of the acquisition of the MuGard Rights and therefore are not presented.