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

Form 10-K

 

 

Commission File Number: 001-33609

SUCAMPO PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

Securities registered pursuant to Section 12(b) of the Exchange Act:

 

 

Securities registered pursuant to Section 12(g) of the Exchange Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 þ     No o

 

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

The aggregate market value of the 11,398,483 shares of class A common stock held by non-affiliates of the registrant (based on the closing price of the registrant’s class A common stock on the last business day of the registrant’s most recently completed second fiscal quarter) was $122 million.

 

As of March 5, 2009, there were outstanding 15,651,849 shares of the registrant’s class A common stock, par value $0.01 per share, and 26,191,050 of the registrant’s class B common stock, par value $0.01 per share.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Portions of the registrant’s Proxy Statement for its 2009 Annual Meeting of Stockholders to be held on May 28, 2009, which Proxy Statement is to be filed within 120 days after the end of the registrant’s fiscal year ended December 31, 2008, are incorporated by reference in Part III of this Annual Report on Form 10-K.

 

 

Sucampo Pharmaceuticals, Inc.

 

Form 10-K

 

Table of Contents

 

 

This Annual Report on Form 10-K, including the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding us and our business, financial condition, results of operations and prospects within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the words “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,” “could,” “will,” “may” or other similar expressions. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and other characterizations of future events or circumstances are forward-looking statements. We cannot guarantee that we will achieve the plans, intentions or expectations expressed or implied in our forward-looking statements. There are a number of important factors that could cause actual results, levels of activity, performance or events to differ materially from those expressed or implied in the forward-looking statements we make. These important factors are described under “Risk Factors” set forth below. In addition, any forward-looking statements we make in this document speak only as of the date of this document, and we do not intend to update any such forward-looking statements to reflect events or circumstances that occur after that date.

 

 

Overview

 

We are an international biopharmaceutical company focused on the discovery, development and commercialization of proprietary drugs based on prostones, a class of compounds derived from functional fatty acids that occur naturally in the human body. We conduct our business through our subsidiaries based in the United States, the United Kingdom and Japan.

 

We believe that most prostones function as activators of cellular ion channels. As a result, prostones appear to be effective at promoting fluid secretion and enhancing cell protection, including recovery of barrier function. This activity may give prostones wide-ranging therapeutic potential, particularly for age-related diseases. We are focused on developing prostone-based compounds for the treatment of gastrointestinal, vascular, respiratory, and central nervous system diseases and disorders for which there are unmet or underserved medical needs and significant commercial potential.

 

The therapeutic potential of prostones was first identified by one of our founders, Dr. Ryuji Ueno. To date, two prostone-based products have received marketing approval: Amitiza^® (lubiprostone) for the treatment of chronic idiopathic constipation in adults and irritable bowel syndrome with constipation in adult women and Rescula^® (unoprostone isopropyl) for the treatment of glaucoma. Rescula, which was developed by R-Tech Ueno, Ltd, or R-Tech, under the leadership of Dr. Ueno and our other founder, Dr. Sachiko Kuno, was the first commercially available prostone-based drug. Although we do not hold any rights to Rescula, we believe that the successful development of Amitiza and Rescula demonstrates the initial therapeutic potential of prostones.

 

Amitiza^® in the United States and Canada

 

In January 2006, we received marketing approval from the U.S. Food and Drug Administration, or FDA, for our first product, Amitiza, for the treatment of chronic idiopathic constipation in adults of all ages. Amitiza is the only prescription product for the treatment of chronic idiopathic constipation that has been approved by the FDA for use by adults of all ages and that has demonstrated safety and effectiveness for use beyond 12 weeks. Constipation becomes chronic when a patient suffers specified symptoms for more than 12 non-consecutive weeks within a 12-month period and is idiopathic if it is not caused by other diseases or by use of medications. Studies published in The American Journal of Gastroenterology estimate that approximately 42 million people in the United States suffer from constipation. Based on these studies, we estimate that approximately 12 million people can be characterized as suffering from chronic idiopathic constipation.

 

In April 2008, we received a second marketing approval from the FDA for Amitiza for the treatment of irritable bowel syndrome with constipation in adult women. Irritable bowel syndrome is a disorder of the intestines with symptoms that include severe cramping, pain, bloating and extreme changes of bowel habits, such as diarrhea or constipation. According to the American College of Gastroenterology, irritable bowel syndrome affects

approximately 58 million people in the U.S. and irritable bowel syndrome with constipation accounts for approximately one-third of these cases.

 

Amitiza increases fluid secretion into the intestinal tract by activating specific chloride channels in cells lining the small intestine. This increased fluid level softens the stool, facilitating intestinal motility and bowel movements. In addition, Amitiza improves symptoms associated with chronic idiopathic constipation, including straining, hard stools, bloating and abdominal pain or discomfort.

 

In October 2004, we entered into a collaboration and license agreement with Takeda Pharmaceutical Company Limited, or Takeda, to jointly develop and commercialize Amitiza for chronic idiopathic constipation, irritable bowel syndrome with constipation, and opioid-induced bowel dysfunction and other gastrointestinal indications in the United States and Canada. Commercial sales of Amitiza were initiated in the United States in April 2006 for the treatment of chronic idiopathic constipation and in May 2008 for the treatment of irritable bowel syndrome with constipation. We retained the rights to develop and commercialize Amitiza in the United States and Canada for indications other than gastrointestinal indications.

 

We are primarily responsible for Amitiza research and development efforts and are the holder of the new drug application, or NDA. Takeda is primarily responsible for the marketing and commercialization of Amitiza in the United States and Canada and markets Amitiza broadly to office-based specialty physicians and primary care physicians in the United States and funds a significant portion of the research and development activities. We have the right to co-promote Amitiza in the U.S. and Canada through a specialty sales force in the institutional marketplace, including specialist physicians based in academic medical centers and long-term care facilities. This institutional market is characterized by a concentration of elderly patients, who we believe to be a key market for Amitiza to treat gastrointestinal indications, and by physicians who are key opinion leaders in the gastrointestinal field.

 

We are currently pursuing marketing approval for Amitiza for opioid-induced bowel dysfunction in patients with non-malignant pain, a constipation-related gastrointestinal indication. In December 2008, we completed enrollment of two phase 3 pivotal clinical trials of Amitiza for this indication. According to the American Pain Foundation, over 50 million Americans suffer from chronic pain, and nearly 25 million Americans experience acute pain each year due to injuries or surgery. Opioid pain relievers are widely prescribed for these patients, many of whom also develop opioid-induced bowel dysfunction.

 

Amitiza in Japan

 

In February 2009, we entered into a license, commercialization and supply agreement with Abbott Japan Co. Ltd., or Abbott, for Amitiza in Japan. Under the terms of the agreement, Abbott received exclusive rights to commercialize lubiprostone for the treatment of chronic idiopathic constipation and also received the right of first refusal to any additional indications for which lubiprostone is developed in Japan. Abbott is responsible for all commercialization expenses and efforts.

 

We received an upfront payment of $10 million and could receive additional milestone payments based on achieving specified development, regulatory, and sales goals. We are continuing to lead the development of and regulatory activity for lubiprostone in Japan and will continue to be responsible for the costs of lubiprostone development.

 

Following marketing authorization and pricing approval, Abbott will purchase finished product from us for distribution in Japan. We have retained the right to co-promote lubiprostone in Japan.

 

In addition, we and Abbott have separately agreed to negotiate in good faith a license, commercialization and supply agreement for lubiprostone for the rest of the world’s markets outside Japan, the U.S., Canada and Western Europe and to use commercially reasonable efforts to enter into such an agreement.

 

In September 2008, we reported the successful results of a multi-center phase 2b dose-ranging trial in Japan to evaluate the safety and efficacy of lubiprostone for treating chronic idiopathic constipation in adults. Based on the results of this trial, we plan to initiate phase 3 clinical testing of lubiprostone for chronic idiopathic constipation in Japan during the second quarter of 2009.

Amitiza in other territories

 

We have retained full rights to develop and commercialize Amitiza for the rest of the world’s markets outside of the U.S., Canada and Japan. We are pursuing marketing approval for Amitiza in Europe and the Asia-Pacific region for appropriate gastrointestinal indications based on local market disease definitions and the reimbursement environment.

 

In February 2008, we submitted a marketing authorization application, or MAA, for lubiprostone, 24 micrograms, for the indication of chronic idiopathic constipation in adults. The MAA was filed using the decentralized procedure, with the United Kingdom, through its Medicines and Healthcare Products Regulatory Agency, serving as the reference member state. Additional applications were subsequently filed with the member states of Belgium, Denmark, France, Germany, Ireland, the Netherlands, Spain and Sweden. These applications were received and validated by the individual regulatory authorities and their formal review process of the applications has begun. We also filed a marketing approval application in Switzerland for the same indication.

 

Other prostone-based product candidates

 

We are developing other prostone-based compounds for the treatment of a broad range of diseases. The most advanced of these programs are:

 

 

Patent and manufacturing arrangements

 

We hold an exclusive worldwide royalty-bearing license to develop and commercialize Amitiza and other prostone-based compounds covered by patents and patent applications from Sucampo AG, an affiliated Swiss patent-holding company. We are obligated to assign to Sucampo AG all patentable improvements that we make in the field of prostones, which Sucampo AG will in turn license back to us on an exclusive basis. Amitiza, cobiprostone and SPI-017 are covered by perpetual licenses that cannot be terminated unless we default in our payment obligations to Sucampo AG. If we have 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 Drs. Ryuji Ueno and Sachiko Kuno, our founders and controlling stockholders, no longer control our company, then the commercial rights to that compound will revert to Sucampo AG, subject to a 15-month extension in the case of any compound that we designate in good faith as planned for development within that extension period.

 

We are party to exclusive supply arrangements with R-Tech Ueno, Ltd., or R-Tech, an affiliated Japanese pharmaceutical manufacturer, to provide us with clinical and commercial supplies of Amitiza and clinical supplies of our product candidates cobiprostone and SPI-017. These arrangements include provisions requiring R-Tech to assist us in connection with applications for marketing approval for these compounds world-wide, including assistance with regulatory compliance for chemistry, manufacturing and controls.

 

Our two founders, Drs. Ueno and Kuno, together, directly or indirectly, own all of the stock of Sucampo AG and a majority of the stock of R-Tech. Drs. Ueno and Kuno also are controlling stockholders of our company and are married to each other. Dr. Ueno is our chief executive officer and the chairman of our board of directors and Dr. Kuno is a member of our board of directors and also serves as our advisor of international business development.

Product Pipeline

 

The table below summarizes the development status of Amitiza and our key product candidates. We currently hold all of the commercialization rights to the prostone compounds in our product pipeline, other than for commercialization of Amitiza in the United States and Canada, which is covered by our collaboration and license agreement with Takeda.

 

 

 

Additionally, we are continuing to conduct pre-clinical studies of six additional preclinical prostone compounds, including two combination candidates, as we focus on development and commercialization of therapies for age-related diseases.

 

Scientific Background of Prostones

 

Prostones are a class of compounds derived from functional fatty acids that occur naturally in the human body.

 

Ion Channel Activation

 

Based on our preclinical studies, we believe that most prostones work as selective ion channel activators, which means that they promote the movement of specific ions into or out of cells. Ions are charged particles, such as sodium, potassium, calcium and chloride ions. The concentration of specific ions within particular types of cells is important to many vital physiological functions, such as maintenance of the membrane potential and control of the activity levels of enzymes and transport molecules. Because ions cannot move freely across cell membranes, they must enter or exit a cell via specific transporters or through protein structures known as ion channels. Ion channels, which are found in every cell in the body, span the cell membrane and regulate the flow of ions into and out of cells by opening and closing in response to particular stimuli, such as changes in membrane potential, ph, cell volume or binding of particular ligands to the channel. Each kind of ion generally moves through its own specific ion channel. Some prostones have been shown to activate or inhibit ion channels, thereby controlling the concentration of specific ions within cells. We believe that these prostones work selectively on specific ion channels and, as a result, can be targeted to induce very specific pharmacological activities without triggering other cellular activity that could lead to undesirable side effects.

 

In preclinical in vitro tests on human cell lines with the three prostones that we are currently developing, Amitiza, cobiprostone and SPI-017, all three compounds activated a specific ion channel known as the type-2 chloride channel, or ClC-2 channel. The ClC-2 channel is expressed in cells throughout the body and is one of the channels through which chloride ions move into and out of cells. Chloride channels regulate many essential physiological functions within cells, including cell volume, intracellular pH, cellular water and ion balance and regulation of potential difference across the cell membrane (membrane potential) and energy levels. We believe that Amitiza is the first selective chloride channel activator approved by the FDA for therapeutic use in humans.

 

Potential Beneficial Effects of Prostones

 

We believe that the mechanism of action of prostones as selective ion channel activators may result in the following beneficial effects:

 

 

 

Products and Product Candidates

 

AMITIZA^® (lubiprostone)

 

Overview

 

We are developing Amitiza for the treatment of multiple constipation-related gastrointestinal disorders. Amitiza functions as an activator of the ClC-2 chloride channel through which negatively charged chloride ions flow out of the cells lining the small intestine and into the intestinal cavity. As these negatively charged chloride ions enter the intestine, positively charged sodium ions move through spaces between the cells into the intestine to balance the negative charge of the chloride ions. As these sodium ions move into the intestine, water is also allowed to pass into the intestine through these spaces between the cells. We believe that this movement of water into the small intestine promotes increased fluid content, which in turn softens the stool and facilitates its movement, or motility, through the intestine.

 

Chronic Idiopathic Constipation

 

On January 31, 2006, the FDA approved our NDA for Amitiza for the treatment of chronic idiopathic constipation in adults of both genders and all ages without restriction as to duration of use. In collaboration with Takeda, we initiated commercial sales of Amitiza in the United States for the treatment of chronic idiopathic constipation in April 2006. When used for this indication, Amitiza gelatin capsules are taken orally twice daily in doses of 24 micrograms each.

 

Disease Overview.  Constipation is characterized by infrequent and difficult passage of stool and becomes chronic when a patient suffers specified symptoms for over 12 non-consecutive weeks within a 12-month period. Chronic constipation is idiopathic if it is not caused by other diseases or by use of medications. Symptoms of chronic idiopathic constipation include straining, hard stools, bloating and abdominal pain or discomfort. Factors contributing to the development of chronic idiopathic constipation include a diet low in soluble and insoluble fiber, inadequate exercise, bowel disorders and poor abdominal pressure and muscular weakness.

 

Current Treatment.  Some patients suffering from chronic idiopathic constipation can be successfully treated with lifestyle modification, dietary changes and increased fluid and fiber intake, and these treatments are generally tried first. For patients who fail to respond to these approaches, physicians typically recommend laxatives, most of which are available over-the-counter. The most commonly used laxatives can be categorized as stimulants, stool softeners, bulk-forming agents, osmotics or lubricants. Though somewhat effective in treating chronic idiopathic constipation, stimulants and stool softeners can be habit forming, while bulk-forming agents are often ineffective in patients with moderate-to-severe constipation. Osmotics, such as MiraLax^tm (polyethylene glycol 3350) and lactulose are labeled for use only for treating occasional constipation, not chronic idiopathic constipation, and they may cause fluid and electrolyte imbalance, which, if left untreated, can impair normal function of the nerves and muscles. MiraLax was approved in late 2008 for sale as an over-the-counter treatment. In addition, lubricants, such as orally administered mineral oil, can be inconvenient and unpleasant for patients to ingest. For those patients who failed to respond to laxatives, Zelnorm^® (tegaserod maleate), a 5-HT4 serotonin-receptor agonist, was often prescribed. However, in March 2007, at the request of the FDA, Zelnorm was withdrawn from the U.S. market by Novartis Pharmaceuticals Corporation, or Novartis. The FDA requested that Novartis discontinue marketing Zelnorm based on a finding of an increased risk of serious cardiovascular adverse events associated with use of the drug. The FDA announced in July 2007 that it would permit the restricted use of Zelnorm under a treatment IND. On

April 2, 2008, after more than eight months of availability, Novartis re-assessed the treatment program and made a decision to close it.

 

Market Opportunity.  Studies published in The American Journal of Gastroenterology estimate that approximately 42 million people in the United States suffer from constipation. In an additional study published in The American Journal of Gastroenterology, 91% of physicians expressed a desire for better treatment options for constipation.

 

We believe that Amitiza has a number of advantages over existing treatment options that could help it capture a significant portion of, and potentially expand, the existing market for chronic idiopathic constipation therapies. These advantages include the following:

 

 

Clinical Trial Results.  In connection with obtaining FDA marketing approval of Amitiza, we conducted a comprehensive program of clinical trials of this drug for use in treating chronic idiopathic constipation. This clinical program included two phase 3 pivotal trials and three long-term safety and efficacy trials.

 

Efficacy Results in Two Pivotal Clinical Trials.  In August 2002 and September 2003, we completed two multi-center, double-blind, randomized, placebo-controlled, four-week, phase 3 clinical trials of substantially identical design to assess the safety and efficacy of Amitiza for the treatment of chronic idiopathic constipation. In each of these trials, we enrolled approximately 240 participants aged 18 or older with a history of chronic idiopathic constipation. The primary efficacy endpoint in these trials was the frequency of spontaneous bowel movements during the first week of treatment. Secondary efficacy endpoints included the frequency of spontaneous bowel movements during the second, third and fourth weeks of treatment, the percentage of participants with a spontaneous bowel movement within 24 hours after administration, the time to first spontaneous bowel movement and weekly subjective assessments by participants of average stool consistency, degree of straining, severity of constipation, overall treatment effectiveness and prevalence of other related symptoms, such as bloating and discomfort.

 

In these trials, Amitiza met its primary efficacy endpoint with statistical significance, increasing the frequency of spontaneous bowel movements from baseline during the first week of treatment by 75% in one pivotal trial and 78% in the second pivotal trial, in each case with a p-value less than 0.0001. In addition, on the basis of combined data from both pivotal trials, Amitiza met all but one of the secondary efficacy endpoints with statistical significance for all treatment weeks. That one secondary efficacy endpoint, abdominal discomfort, showed statistically significant improvements only during the last two weeks of treatment with Amitiza compared to placebo. The results of these trials were consistent in subpopulation analyses for gender, race and patients 65 years of age or older. We determined statistical significance based on a widely used, conventional statistical method that establishes the p-value of clinical results. Under this method, a p-value of 0.05 or less represents statistical significance, meaning that there is a less than one-in-twenty likelihood that the observed results occurred by chance.

 

Efficacy Results in Long-term Safety Trials.  Between November 2001 and January 2005, we conducted three multi-center, open-label, long-term clinical safety and efficacy trials of Amitiza in patients with a history of chronic idiopathic constipation. The trials consisted of one six-month trial and two twelve-month trials and enrolled a total of 881 patients age 18 or older. The primary objective of these trials was to demonstrate the safety of Amitiza when administered to participants in twice-daily doses of 24 micrograms each. A secondary objective was to provide further evidence of the long-term efficacy of Amitiza in treating the symptoms of chronic idiopathic constipation. In these trials, Amitiza produced statistically significant improvements from baseline in subjective assessments of constipation severity, abdominal bloating and abdominal discomfort over both the six-month and the twelve-month treatment periods with a p-value less than or equal to 0.0001. Subjective assessment of constipation severity was improved by an average of 1.47 points on a five-point scale in the six-month trial and 1.38 points in the twelve-month trial; subjective assessment of abdominal bloating was improved by an average of 0.98 points in the six-

month trial and 1.00 points in the twelve-month trial; and subjective assessment of abdominal discomfort was improved by an average of 0.91 points in the six-week trial and 0.87 points in the twelve-month trial.

 

Safety Profile and Withdrawal Effects.  Amitiza was well tolerated in twice-daily doses of 24 micrograms each in an earlier phase 2 trial, the two phase 3 pivotal trials and the three long-term clinical safety and efficacy trials. These trials revealed no apparent increased risk of serious adverse events as a result of treatment with Amitiza. The most common adverse events reported by participants in these six trials were nausea, which was reported by 31% of all trial participants, and diarrhea and headache, which were each reported by 13% of all trial participants. The incidence of nausea was lower among participants 65 years of age or older, with only 18.6% of those participants reporting this side effect. In addition, because Amitiza demonstrated a potential to cause fetal loss in guinea pigs in preclinical studies, its label provides that it should be used during pregnancy only if the potential benefit justifies the potential risk to the fetus. The label further states that women who could become pregnant should have a negative pregnancy test prior to beginning therapy with the drug and should be capable of complying with effective contraceptive measures.

 

Post-marketing Studies.  In connection with our marketing approval for Amitiza for the treatment of chronic idiopathic constipation in adults, we committed to the FDA to conduct post-marketing studies to evaluate the safety of the product in pediatric patients, patients with renal impairment and in patients with hepatic impairment. We initiated the studies in January 2007. We completed the study in patients with renal impairment and submitted the clinical study report to the FDA in April 2008. We have completed the study in patients with hepatic impairment and studies in pediatric patients and our analysis of results are under way.

 

Japanese Studies.  In November 2007, we commenced a multi-center phase 2b dose-ranging study in Japan to evaluate the safety and efficacy of lubiprostone for chronic idiopathic constipation in adults. This randomized, parallel group, double-blind, placebo-controlled study compared the dose response of oral lubiprostone with that of placebo in Japanese patients diagnosed with chronic idiopathic constipation. The study evaluated 170 patients who were randomized to one of three twice-daily doses of lubiprostone (8, 16 or 24 micrograms) or placebo. Participants in the study had a statistically significant increase in the mean change in spontaneous bowel movements, or SBM, from baseline after one week on treatment, the study’s primary endpoint, for patients taking Amitiza 24 micrograms twice daily versus placebo, with a p. value of less than .0001. Patients taking Amitiza 24 micrograms also had statistically significant improvement versus placebo for several secondary endpoints, including change in SBM after two weeks, mean weekly SBM, percentage of patients having first SBM within 24 and 48 hours, degree of straining and stool consistency, abdominal bloating, abdominal discomfort, global assessment of severity of constipation, global assessment of treatment efficacy as well as quality of life evaluation of treatment satisfaction.

 

Amitiza was well-tolerated with the most commonly reported adverse events, reported in greater than 5% of patients, being diarrhea, nausea, and stomach discomfort, which are consistent with previously reported Amitiza data.

 

Irritable Bowel Syndrome with Constipation

 

On April 29, 2008, the FDA approved our supplemental NDA, or sNDA, for Amitiza for the treatment of irritable bowel syndrome with constipation in adults. In collaboration with Takeda, we initiated commercial sales of Amitiza in the United States for this indication in May 2008. When used for this indication, Amitiza gelatin capsules are taken orally twice daily in doses of 8 micrograms each.

 

Disease Overview.  Irritable bowel syndrome is a disorder of the intestines with symptoms that include severe cramping, pain, bloating and extreme changes of bowel habits, such as diarrhea or constipation. Patients diagnosed with irritable bowel syndrome are commonly classified as having one of three forms: irritable bowel syndrome with constipation, irritable bowel syndrome with diarrhea, or mixed-pattern irritable bowel syndrome alternating between constipation and diarrhea. Currently, irritable bowel syndrome in all its forms is considered to be one of the most common gastrointestinal disorders.

 

Current Treatment.  Most treatment options for irritable bowel syndrome with constipation focus on separately addressing symptoms, such as pain or infrequent bowel movements. Some patients suffering from irritable bowel syndrome with constipation can be successfully treated with dietary measures, such as increasing

fiber and fluid intake, and these treatments are generally tried first. If these measures prove ineffective, laxatives are frequently used for the management of this condition. Zelnorm was the only FDA-approved drug indicated for the treatment of irritable bowel syndrome with constipation before it was withdrawn in March 2007. In December 2005, the European Medicines Agency denied marketing approval for Zelnorm for the treatment of irritable bowel syndrome with constipation in women, citing the inconclusiveness of clinical studies in demonstrating its effectiveness. In March 2006, the agency denied an appeal of that decision.

 

Market Opportunity.  According to the American College of Gastroenterology, irritable bowel syndrome affects approximately 58 million people in the United States, and irritable bowel syndrome with constipation accounts for approximately one-third of these cases.

 

Development Status.  In June 2004, we completed a multi-center, double-blind, randomized, placebo-controlled, dose-response, 12-week phase 2 clinical trial to assess the safety and efficacy of Amitiza for the treatment of irritable bowel syndrome with constipation in daily doses of 16, 32 and 48 micrograms. In this trial, we enrolled approximately 200 participants meeting the International Congress of Gastroenterology’s working criteria for the diagnosis of irritable bowel syndrome with constipation, referred to as the Rome II criteria. The objective of this trial was to evaluate the safety and efficacy of multiple dose levels of Amitiza in this patient population in order to select the appropriate dose for phase 3 pivotal studies.

 

The primary efficacy endpoint for this trial was a subjective assessment of changes in abdominal discomfort and pain during the first month of treatment. Secondary efficacy endpoints included subjective assessments of changes in abdominal discomfort and pain during the second and third months of treatment, frequency of spontaneous bowel movements, subjective assessments of average stool consistency, degree of straining, abdominal bloating, severity of constipation and overall treatment effectiveness and subjective assessment of quality of life.

 

In this trial, Amitiza demonstrated a statistically significant, dose-dependent trend in improvement in mean change from baseline abdominal discomfort and pain during the first month of treatment with a p-value of 0.0431. The term mean change from baseline refers to differences in patients’ condition after treatment with the drug or the placebo compared to their condition before treatment. This dose-dependent trend in improvement in mean change from baseline also was statistically significant during the second month of treatment with a p-value of 0.0336. During the third month of treatment, the trend in favor of Amitiza continued, but was not statistically significant. Several secondary efficacy endpoints, including frequency of spontaneous bowel movements, subjective assessments of average stool consistency, degree of straining, abdominal bloating and severity of constipation, also showed overall dose-dependent trends that were statistically significant for at least two of the three months of treatment.

 

Although Amitiza was effective and well tolerated at all doses in this trial, the 16 microgram daily dose produced the best overall balance of safety and efficacy, with participants in the 32 and 48 microgram treatment groups generally more likely to discontinue treatment due to adverse events. Adverse events appeared to be dose-dependent between the 16 and 48 microgram Amitiza treatment groups and occurred more frequently in the Amitiza treatment group than in the placebo treatment group.

 

Based on the results of this phase 2 trial, we initiated two pivotal phase 3 clinical trials of Amitiza in men and women for irritable bowel syndrome with constipation in May 2005, each involving 570 or more participants meeting the Rome II criteria for irritable bowel syndrome with constipation at 65 investigative study sites in the United States. These phase 3 pivotal trials were designed as double-blind, randomized, 12-week clinical trials to demonstrate the efficacy and safety of Amitiza for the treatment of symptoms of irritable bowel syndrome with constipation using twice daily doses of 8 micrograms each, or 16 micrograms total. The primary efficacy endpoint for these trials was a subjective assessment of the participant’s overall relief from the symptoms of irritable bowel syndrome with constipation determined by the question “How would you rate your relief of irritable bowel syndrome symptoms (abdominal discomfort/pain, bowel habits, and other irritable bowel syndrome symptoms) over the past week compared to how you felt before you entered the study?” Patient responses were recorded using a seven-point balanced scale. Treatment responders were defined in each month as those reporting at least “significantly relieved”, which was the highest scale category, for two out of four weeks or “moderately relieved”, the second highest category, for four out of four weeks. To qualify as an overall treatment responder, and count toward the primary efficacy endpoint, patients had to be a monthly treatment responder for at least two out of three months.

The secondary efficacy endpoints were similar to those for our phase 2 clinical trials of Amitiza for this indication and involved subjective assessments of such factors as abdominal discomfort and pain, bloating, straining, stool consistency, severity of constipation and quality of life components. The first of the two pivotal studies was followed by a randomized withdrawal period to assess the effects, if any, associated with withdrawal of Amitiza over a four-week period. We also initiated an additional follow-on open-label safety and efficacy study to assess the long-term use of Amitiza as a treatment for this indication. This study included 476 patients who were treated for an additional 36 weeks following the initial 12 or 16 week treatment period.

 

In the two pivotal phase 3 trials, participants receiving Amitiza at a dose of 8 micrograms twice daily were more likely to achieve overall relief from symptoms compared to those receiving the placebo, with 17.9% of the Amitiza group achieving overall relief compared to 10.1% for the placebo group, with a p-value of 0.001. In both trials individually, participants receiving Amitiza experienced overall relief from symptoms at higher rates than those receiving the placebo, 18.2% compared to 9.8% with a p-value of 0.009 in one trial and 17.7% compared to 10.4% with a p-value of 0.031 in the other.

 

In the combined phase 3 trials, the secondary endpoints, which were measured on a five-point scale, were improved with statistical significance in participants receiving Amitiza compared to those receiving the placebo. At the end of the three-month treatment period, subjective assessments of abdominal discomfort and pain by participants receiving Amitiza improved from baseline by an average of 0.45 points, compared to average improvements in participants receiving the placebo of 0.35 points; subjective assessments of stool consistency improved by an average of 0.51 points compared to 0.38 points; subjective assessments of straining improved by an average of 0.60 points compared to 0.47 points; subjective assessments of constipation severity improved by an average of 0.52 points compared to 0.40 points; and subjective assessments of abdominal bloating improved by an average of 0.45 points compared to 0.36 points. At the end of the three-month treatment period, the overall composite score for subjective assessments of quality of life improved from baseline an average of 17.1 points on a 100-point scale for participants receiving Amitiza compared to an average improvement of 14.4 points for those receiving the placebo. Statistical significance was seen for each of these secondary endpoints, with the subjective assessments of abdominal discomfort and pain having a p-value of 0.013, stool consistency having a p- value of 0.006, straining having a p-value of 0.020, constipation severity having a p-value of 0.005, abdominal bloating having a p-value of 0.024 and quality of life having a p-value of 0.021.

 

The first of the two phase 3 trials also assessed the rebound effect from the withdrawal of Amitiza following 12 weeks of treatment with an 8 microgram dose twice daily. In this trial, withdrawal of Amitiza did not result in a rebound effect. Amitiza was well-tolerated in the phase 2, phase 3, and long-term safety studies. In the combined phase 2 and phase 3 studies and at the recommended dose, there was a similar incidence of serious adverse events, 1% in both the Amitiza group and the placebo group, and treatment-related adverse events, with 26% in the Amitiza groups compared to 21% in the placebo groups. The most common treatment-related adverse events were nausea, which was reported by 8% of participants receiving Amitiza and 4% of those receiving the placebo, and diarrhea, which was reported by 7% of the Amitiza groups and 4% of the placebo groups. Abdominal pain occurred at a similar rate in the placebo groups and the Amitiza groups, with 5% reporting this adverse event.

 

Opioid-Induced Bowel Dysfunction

 

Disease Overview.  Opioid-induced bowel dysfunction comprises a variety of gastrointestinal side effects originating from the use of narcotic medications such as morphine and codeine, which are referred to as opioids. Physicians prescribe opioids for patients with advanced illnesses, such as cancer and AIDS, patients undergoing surgery and patients who experience chronic pain. Despite their pain-relieving effectiveness, opioids are known to produce gastrointestinal side effects that lead to opioid-induced constipation, including inhibition of large intestine motility, decreased gastric emptying and hard stools.

 

Current Treatment.  There are currently no FDA-approved oral products that are specifically indicated for treatment of opioid-induced bowel dysfunction. Current treatment options for opioid-induced bowel dysfunction include the use of stool softeners, enemas, suppositories and peristaltic stimulants such as senna, which stimulate muscle contractions in the bowel. The effectiveness of these products for the treatment of opioid-induced bowel dysfunction is limited due to the severity of the constipation caused by opioids. In addition, physicians often cannot

prescribe peristaltic stimulants for the duration of narcotic treatment because of the potential for dependence upon these stimulants. The FDA recently approved Relistor (methylnaltrexone bromide) for opioid-induced constipation in patients with late-stage and advanced illness who experience severe constipation. However, Relistor is available only as an injectable medication and is not recommended for patients with known or suspected intestinal obstructions. Common side effects of Relistor include abdominal pain, gas, nausea, dizziness and diarrhea.

 

Market Opportunity.  According to the American Pain Foundation, over 50 million Americans suffer from chronic pain, and nearly 25 million Americans experience acute pain each year due to injuries or surgery. Opioid pain relievers are widely prescribed for these patients, many of whom also develop opioid-induced bowel dysfunction. We believe over three million people in the United States currently suffer from opioid-induced bowel dysfunction.

 

Opioid drugs are known to increase absorption of electrolytes, including chloride, in the small intestine, contributing to the constipating effects of these analgesics.

 

We believe that Amitiza, as a chloride channel activator, may directly counteract this side effect without interfering with the analgesic benefits of opioids. As a result, we believe that Amitiza, if approved for the treatment of opioid-induced bowel dysfunction, could hold a competitive advantage over drugs that do not work through this mechanism of action.

 

Development Status

 

We have completed preclinical studies of Amitiza as a potential therapy for opioid-induced bowel dysfunction. In a model of morphine-induced constipation in mice, Amitiza was shown to improve intestinal transit time and did not result in any reduction of the analgesic effect of morphine. Based on these preclinical results, we determined to pursue development of Amitiza as a treatment for opioid-induced bowel dysfunction.

 

We commenced two pivotal phase 3 clinical trials of orally administered Amitiza for the treatment of opioid-induced bowel dysfunction in September 2007. Each trial enrolled approximately 420 participants at 190 participating sites. These phase 3 pivotal trials are designed as double-blind, randomized, 12-week clinical trials to demonstrate the efficacy and safety of Amitiza for the treatment of opioid-induced bowel dysfunction in adults using twice daily doses of 24 micrograms each, or 48 micrograms total. The primary efficacy endpoint for these trials is the change from baseline in SBM frequency at week 8. In addition, several secondary endpoints include change from baseline in SBM frequency at week 12 and overall; percentage of patients with a first post-dose SBM within 24 hours or 48 hours; overall responder rates; overall mean change from baseline in straining, stool consistency, constipation severity, abdominal bloating, abdominal discomfort, and bowel habit regularity; and overall treatment effectiveness. These two pivotal trials, which were fully enrolled in late November 2008, are being followed by a nine month open-label extension trial in approximately 440 participants to assess the long-term safety and efficacy profile of Amitiza in subjects with opioid-induced bowel dysfunction.

 

Cobiprostone

 

Overview

 

We are developing the prostone compound cobiprostone for oral administration to treat various gastrointestinal and liver disorders, including NSAID-induced ulcers and portal hypertension. We also plan to develop an inhaled formulation of cobiprostone for the treatment of respiratory symptoms of cystic fibrosis and chronic obstructive pulmonary disease. We believe that cobiprostone, like Amitiza, is an activator of the chloride ion channel ClC-2, which is known to be present in gastrointestinal, liver and lung cells. We are also developing cobiprostone as a topical preparation for the treatment of ulcers and wounds based on preclinical results from coetaneous tissue blood flow studies and incision wound healing studies.

 

We completed two phase 1 clinical trials of cobiprostone in healthy volunteers in Japan in 1997. In these trials, orally administered cobiprostone was generally well tolerated both when it was administered three times daily for a period of seven days at doses we expect to be clinically relevant and when it was administered in single doses that were significantly higher than those we expect to be clinically relevant. Several incidents of loose or watery stools were reported, but at doses higher than those we expect to use in planned additional clinical trials. No serious

adverse events were experienced by any participants in these trials, and no participants withdrew from these trials due to adverse events, even at dose levels several times higher than what we expect to be clinically-relevant doses of cobiprostone.

 

Non-Steroidal Anti-Inflammatory Drug-Induced Ulcers

 

We commenced a phase 2 clinical trial of cobiprostone for the prevention and treatment of NSAID-induced ulcers in September 2007.

 

Disease Overview.  NSAIDs, such as aspirin and ibuprofen, are among the most commonly prescribed drugs worldwide. They are used to treat common medical conditions, such as arthritis, headaches and fever. In addition, with the recent withdrawal from the marketplace of the COX-2 inhibitors Vioxx^® (rofecoxib) and Bextra^® (valdecoxib), which were widely prescribed for arthritis patients, an increased number of these patients are returning to NSAID therapy. However, gastrointestinal symptoms, such as gastric, or stomach, ulcers and bleeding, are major limiting side effects of long-term NSAID use.

 

Current Treatment.  Current treatment options for NSAID-induced ulcers include products designed to prevent the formation of gastric ulcers during NSAID use and products that help to repair the damage of ulcers after they have developed. Cytotec^® (misoprostol) is currently the only FDA approved product for the prevention of NSAID-induced gastric ulcers. It is sometimes marketed as a combination product with NSAIDs under the brand name Arthrotec^®. However, Cytotec has been associated with severe diarrhea, particularly in higher doses, and its label restricts its use in women of childbearing potential, except in very limited circumstances, because it can cause abortion, premature birth and birth defects.

 

After NSAID-induced ulcers have developed, proton pump inhibitors, such as Nexium^® (esomeprazole magnesium) and Prevacid^® (lansoprazole), are prescribed to treat most gastric ulcer patients, either alone or in combination with other treatments. H2 receptor blockers, such as Pepcid^® (famotidine), Tagamet^® (cimetidine) and Zantac^® (ranitidine hydrochloride), help to reduce stomach acid and are typically prescribed as a second line of therapy for gastric ulcers, when proton pump inhibitors are not effective, or are used in conjunction with proton pump inhibitors. Although both proton pump inhibitors and H2 blockers can aid in the repair of existing gastric ulcers, neither of these drug categories has been shown to be effective in preventing ulcer development. Furthermore the therapeutic effects of these products are only observed at high doses and in some types of at-risk patients, such as those with a prior history of ulcers or those 65 years of age or older.

 

Market Opportunity.  According to a study published in Postgraduate Medicine, approximately 13 million patients in the United States are regular users of NSAIDs. According to the American Chronic Pain Association, as many as 20% of patients who take NSAIDs daily may develop gastric ulcers. We believe that many patients treated with NSAIDs are not prescribed preventative treatment for gastric ulcers due to a combination of high cost, side effects and lack of a well established standard of care. We believe that these factors also limit the use of prescription products for the repair of gastric ulcers after they have developed. Based on cobiprostone’s novel mechanism of action and protective activity in animal models, we believe that it may be effective at both preventing and treating NSAID-induced ulcers, but without the safety concerns and restrictions on use associated with existing treatment options.

 

Development Status.  We have completed preclinical studies of cobiprostone as a potential therapy for the prevention of NSAID-induced ulcers. In preclinical tests in rats, cobiprostone protected against formation of ulcers induced by indomethacin, an NSAID, and ulcers induced by stress and demonstrated an acceptable safety profile at what we believe are clinically relevant doses. In the third quarter of 2007, we commenced a phase 2 clinical trial for cobiprostone. This phase 2 multi-center, randomized, placebo-controlled study was fully enrolled at the end of December 2008 with 124 participants at 12 sites. The trial is designed to assess the efficacy and safety of cobiprostone in preventing nonsteroidal anti-inflammatory drug induced gastroduodenal injury in patients taking Naproxen 500mg twice daily. Study patients are randomized to one of three daily doses of cobiprostone (18, 36 or 54 micrograms) or placebo. The efficacy endpoints for the trial include the overall incidence of gastric, duodenal, and gastroduodenal ulcers, the incidence of gastric, duodenal, and gastroduodenal ulcers and erosions at weeks 4, 8, and 12, the changes in numbers of ulcers and erosions, and evaluation of GI mucosa ischemia. We believe that cobiprostone may have utility in preventing other gastric injury in addition to NSAID-induced ulcers. Accordingly,

as we progress through our clinical program for cobiprostone, we may seek to broaden our indication for this compound by exploring other gastrointestinal lesions, including hemorrhages, erosions and ulcerations.

 

Other Potential Indications

 

Portal Hypertension.  Portal hypertension is the build-up of pressure in the portal vein connecting the intestines and the liver and is caused by a narrowing of the blood vessel as a result of liver cirrhosis. Increased pressure in the portal vein can lead to the development of large, swollen veins in the esophagus, stomach and rectum which, if ruptured, can result in potentially life-threatening blood loss.

 

In preclinical tests, cobiprostone:

 

 

In the third quarter of 2008, we commenced a phase 2 proof-of-concept study of cobiprostone in patients with portal hypertension. The trial was designed to assess the efficacy and safety of an initial single oral dose of cobiprostone at 36 or 54 micrograms, followed by multiple doses of cobiprostone at 36 micrograms/day (12 micrograms three times daily) and 54 micrograms/day (18 micrograms three times daily) over a four — week period. The trial was discontinued in December 2008 due to lower than anticipated enrollment resulting from lack of patient eligibility interest and study compliance. The trial design is being reviewed to determine if future study for this indication is warranted.

 

Cystic Fibrosis.  Cystic fibrosis is a congenital disease that usually develops during childhood and causes pancreatic insufficiency and pulmonary disorder. The gene product responsible for cystic fibrosis is a protein called the cystic fibrosis transmembrane conductance regulator, or CFTR. CFTR is found in cells lining the internal surfaces of the lungs, salivary glands, pancreas, sweat glands, intestine and reproductive organs and acts as a channel transporting chloride ions out of the cell. Cystic fibrosis is caused by a defect in the CFTR protein, which prevents the transport of chloride ions out of cells, causing the body to develop thick, sticky mucus in the lungs, pancreas and liver. According to the Cystic Fibrosis Foundation, cystic fibrosis currently affects approximately 30,000 people in the United States and is usually diagnosed in infants and children.

 

In preclinical in vitro tests on human cell lines, cobiprostone acted as an ion transport modulator, facilitating transport of chloride ions across cell membranes through the ClC-2 chloride channel, a transport process different from that which is defective in cystic fibrosis patients. We believe that the ability of cobiprostone to activate chloride transport using an alternate chloride channel could potentially reverse the effects caused by the defective CFTR, reducing mucus viscosity and allowing increased clearance of mucus in the lungs, pancreas and liver.

 

In 2003, we conducted an open-label, dose-escalating phase 2 trial of orally administered cobiprostone in 24 participants with documented cystic fibrosis. These participants were assigned to one of three dose cohorts at four sites in the United States and treated with cobiprostone for seven days. Cobiprostone was generally well tolerated by trial participants, although one participant experienced a serious adverse event and was hospitalized for exacerbation, or short-term worsening, of the disease, possibly as a result of treatment with cobiprostone. Although this trial focused primarily on safety, we also examined the effect of cobiprostone on chloride secretion in cells lining the nose and salivary glands as well as overall quality of life as measured by a questionnaire published by the Cystic Fibrosis Foundation. The results for chloride secretion were inconclusive, which we believe was likely due to the rapid metabolization of the drug in the gastrointestinal tract, the short duration of the trial and the limited number of participants enrolled in the trial. As a result, we are focusing our initial development efforts on an inhaled formulation of cobiprostone for the treatment of respiratory symptoms of cystic fibrosis.

 

Chronic Obstructive Pulmonary Disease.  Chronic obstructive pulmonary disease is characterized by the progressive development of airflow limitation in the lungs that is not fully reversible and encompasses chronic bronchitis and emphysema. According to the National Heart, Lung and Blood Institute, or the NHLBI, a division of the National Institutes of Health, approximately 12 million adults 25 years of age or older in the United States are

diagnosed with chronic obstructive pulmonary disease. The NHLBI further estimates that approximately 24 million adults in the United States have evidence of impaired lung function, indicating in their view that this disease is under diagnosed. Anticholinergics, smooth muscle relaxers that can help to widen air passageways to the lungs, have been the primary therapy to treat chronic obstructive pulmonary disease. Recently, combination agents, such as steroid/Beta-2 agonists, have enjoyed increased use as chronic obstructive pulmonary disease treatments. However, these treatments relieve only the symptoms of chronic obstructive pulmonary disease, such as chronic cough or shortness of breath, and have limited effect on reducing the incidence of exacerbation of the disease.

 

Because we believe that the method of action of cobiprostone involves a barrier protection function resulting from chloride channel activation, we believe that it may be able to address multiple respiratory treatment needs, including treatment of exacerbations, chronic excessive mucus secretion and the mucus component of chronic bronchitis. In pharmacological testing using an inhaled formulation of cobiprostone in a guinea pig model to assess changes in respiratory and pulmonary function, cobiprostone reduced cigarette smoke-induced airway resistance and restored forced expiratory volume. We plan to conduct additional preclinical testing of this inhaled formulation of cobiprostone as a potential treatment for chronic obstructive pulmonary disease.

 

SPI-017

 

Overview

 

We are conducting preclinical development of SPI-017 for the treatment of peripheral arterial and vascular disease, central nervous system disorders. Initially, we are working on the development of an intravenous formulation of SPI-017 for the treatment of peripheral arterial disease and stroke. We also are developing an oral formulation of SPI-017 for the treatment of Alzheimer’s disease.

 

We commenced a phase 1 clinical trial of the intravenous formulation of SPI-017 in December 2008. We also plan to commence a phase 1 clinical trial of the oral formulation in 2009. Results from the phase 1 trials of both the intravenous and the oral formulations may be useful in the development of multiple indications.

 

In preclinical in vitro tests on human cell lines, SPI-017 activated chloride and potassium channels in very low concentrations on a variety of cell types found in the central nervous system and peripheral blood vessels. We are currently evaluating the safety profile of various SPI-017 dosage forms in preclinical toxicology studies.

 

Potential Indications

 

Peripheral Arterial and Vascular Disease.  Peripheral arterial disease, which also is sometimes referred to as peripheral vascular disease, is a chronic condition that results from narrowing of the vessels that supply blood to the stomach, kidneys, arms, legs and feet. Peripheral arterial disease is caused by the build-up of fatty deposits, or plaque, in the inner walls of the arteries as a result of a vascular condition known as atherosclerosis. This build-up of plaque restricts the flow of blood throughout the body, particularly in the arms and legs, and can lead to painful cramping and fatigue after exercise. The American Heart Association estimates that peripheral arterial disease affects as many as 8 million to 12 million people in the United States.

 

Anti-platelet medications, vasodilators and prostaglandins represent the most frequently prescribed treatments for peripheral arterial disease, but they have little or no impact on symptoms or the underlying atherosclerotic process. Palux^® (alprostadil) and Liple^® (alprostadil) are used for the treatment of chronic arterial occlusion in Japan, but alprostadil is not approved for this indication in the United States. In addition, Palux and other prostaglandin E1 drug products should not be administered to patients with bleeding disorders or patients being treated with chronic anti-platelet medications, such as aspirin, due to the detrimental effect of these products on platelet aggregation. Despite the need for additional treatments, we believe that few novel therapies are being explored.

 

In preclinical animal studies, intravenously administered SPI-017 counteracted blood vessel constriction induced by a chemical agent without significantly affecting blood pressure. In addition, in preclinical animal studies, SPI-017 had no effect on platelet aggregation. We believe that this may suggest that SPI-017, unlike Palux and other prostaglandin E1 drugs, could be used to treat patients with bleeding disorders or patients being treated

with chronic anti-platelet medications. We are planning additional experiments to further test the activity of SPI-017 in animal models of peripheral arterial disease.

 

Stroke.  Ischemic stroke occurs when an artery that supplies blood to the brain becomes blocked due to a blood clot or other blockage or when blood flow is otherwise reduced as a result of a heart condition. During ischemic stroke, a high rate of damage of neuronal cells in the brain usually leads to permanent functional loss. The American Heart Association estimates that approximately 700,000 patients in the Unites States suffer strokes annually, 88% of which are ischemic strokes.

 

The thrombolytic Activase^® (alteplase, recombinant) is the principal drug currently used to treat acute ischemic stroke in the United States. To be effective, treatment with Activase must be initiated within three hours after the onset of stroke symptoms. In addition, because Activase is contraindicated in patients with intracranial hemorrhaging or active internal bleeding, treatment should be initiated only after exclusion of these conditions.

 

Intravenously administered SPI-017 reduced the extent of cerebral tissue damage in experimentally induced ischemic stroke in rats. In these studies, intravenous SPI-017 administered shortly after the restoration of blood flow also significantly reduced the extent of tissue damage. We are planning additional animal tests to further define the time window for administration of SPI-017 and the concentration range.

 

Alzheimer’s Disease.  Alzheimer’s disease is a chronic debilitating disease, with patients suffering from a progressive dementia over a number of years, ultimately resulting in severe incapacitation and a shortened lifespan. According to the Alzheimer’s Association, there are approximately 4.5 million Alzheimer’s disease patients in the United States.

 

The brain comprises a complex network of neurons that enable memory, sensation, emotion and other cognitive functions. Neurons are highly specialized cells that are capable of communicating with each other through biochemical transmission across junctions called synapses. For this communication to occur, neurons secrete chemicals, known as neurotransmitters, which bind to receptors on neighboring neurons. Coordinated communication across synapses is essential for the formation of memories. The molecular mechanisms and hypotheses of Alzheimer’s disease are complex.

 

Several classes of ion channels play a critical role in both the activation of neurons and in the secretion of neurotransmitters across synapses. In particular, some classes of potassium ion channels, sodium ion channels and calcium ion channels have been shown to be critical in the cascade of events that leads to the secretion of neurotransmitters in key regions of the brain associated with memory. We believe that some of these channels may be important in the process of memory formation and retention.

 

Preclinical studies of SPI-017 in a cholinergic lesion rat model of Alzheimer’s disease suggest that orally administered SPI-017 facilitates memory formation and cognitive behaviour. In addition, the survival and structural integrity of cholinergic neurons in the nucleus basalis magnocellularis were preserved in SPI-017 treated animals. The efficacy of SPI-017 was comparable to Aricept, an acetylcholine esterase inhibitor which is currently marketed for the treatment of moderate to severe Alzheimer’s disease. Since the mechanisms of action of SPI-017 are different from inhibition of neuronal acetylcholine esterase we are planning additional studies to further test the activity of SPI-017 in different animal models of Alzheimer’s disease.

 

Marketing and Sales

 

In 2006, we exercised the co-promotion rights under our collaboration and license agreement with Takeda to begin developing a specialized sales force to market Amitiza to complement Takeda’s marketing efforts among primary care physicians. We have implemented a selling model that we believe has produced increased sales growth for Amitiza in geographies covered by a Sucampo representative within the United States.

 

Takeda markets Amitiza broadly to office-based specialty physicians and primary care physicians in the United States. We complement Takeda’s marketing efforts by promoting Amitiza through a specialty sales force in the institutional marketplace, including specialist physicians based in academic medical centers and long-term care facilities. This institutional market is characterized by a concentration of elderly patients, who we believe to be a

key market for Amitiza to treat gastrointestinal indications, and by physicians who are key opinion leaders in the gastrointestinal field.

 

We intend to evaluate strategic acquisitions, in-licensing or co-promotion opportunities to supplement our existing product pipeline, especially those that would add products complementary to the focus of our specialty sales force.

 

Takeda Collaboration

 

In October 2004, we entered into a 16-year collaboration and license agreement with Takeda to jointly develop and commercialize Amitiza for gastrointestinal indications in the United States and Canada. This agreement provides Takeda with exclusive rights within these two countries to develop and commercialize Amitiza for these indications under all relevant patents, know-how and trademarks. Takeda does not have the right to manufacture Amitiza. Instead, Takeda is required to purchase all supplies of the product from R-Tech under a supply and purchase agreement between Takeda and R-Tech.

 

Development Costs.  The agreement provides for development cost-sharing arrangements in which Takeda funds all development costs for the development of Amitiza as a treatment for chronic idiopathic constipation and irritable bowel syndrome with constipation up to $30.0 million, of which we received the full amount in 2005. We are required to fund the next $20.0 million in development costs for these two indications, and all development costs in excess of $50.0 million are shared equally between Takeda and us. In addition, Takeda and we share equally in all external costs of regulatory-required studies up to $20.0 million, with Takeda funding any remaining costs related to such studies. For any additional indications beyond chronic idiopathic constipation and irritable bowel syndrome with constipation and for new formulations of Amitiza, Takeda has agreed to fund all development costs, including regulatory-required studies, to a maximum of $50.0 million for each new indication and $20.0 million for each new formulation. Takeda and we have agreed to share equally all costs in excess of these amounts. With respect to any studies required to modify or expand the label for Amitiza for the treatment of chronic idiopathic constipation or irritable bowel syndrome with constipation, Takeda has agreed to fund 70% of the costs of such studies and we have agreed to fund the remainder. With respect to the development costs for Amitiza for the treatment of chronic idiopathic constipation in pediatric patients, the joint commercialization committee described below has determined that such costs will be funded entirely by Takeda.

 

Commercialization Funding Commitment.  Takeda is obliged to maintain a specific level of funding for activities in relation to the commercialization of Amitiza. If we and Takeda jointly determine to conduct a full-scale direct-to-consumer television advertising campaign for Amitiza, Takeda’s funding obligation for commercialization activities will be $80.0 million per year for three years. If there is no full-scale direct to consumer advertising campaign in a 12 month period, then the total commercialization funding commitment will be $40.0 million per year for a three year period following the NDA approval for the irritable bowel syndrome with constipation indication.

 

Promotion and Marketing.  Takeda is required to provide a dedicated sales force of at least 200 people to promote Amitiza and a supplemental sales force of 500 people to promote Amitiza together with one other drug product. In addition, Takeda is required to perform specified minimum numbers of product detail meetings with health care professionals throughout the term of the agreement depending upon the indications for which Amitiza has been approved.

 

Co-Promotion Rights.  Under the agreement, we retained co-promotion rights, which we exercised in February 2006, resulting in a related supplemental agreement. In connection with our exercise of these rights, we agreed to establish our own specialty sales force consisting of a team of approximately 38 field sales representatives. The supplemental agreement provides that Takeda will fund a portion of our sales force costs, for a period of five years from the date we first deploy our sales representatives. We may increase the total number of our sales representatives and receive additional funding from Takeda for any related costs up to a specified annual amount, subject to the unanimous approval of the joint commercialization committee described below.

 

Medical and Scientific Activities.  We also are entitled to receive cost reimbursement from Takeda on a case-by-case negotiated basis for a part of our commercialization efforts with respect to specific medical and

scientific activities undertaken by us. Takeda is to retain overall responsibility for managing these medical and scientific activities. We were responsible for the development of all publications directed at a scientific audience until January 31, 2007, with this work being reimbursed by Takeda up to a specified limit. We retain all intellectual property rights over the material in these publications. After January 31, 2007, Takeda is primarily responsible for the development of these publications.

 

Licensing Fees, Milestone Payments and Royalties.  Takeda made an up-front payment of $20.0 million in 2004 and has paid total development milestone payments of $130.0 million through December 31, 2008. Subject to reaching future development and commercial milestones, we are entitled to receive up to $10.0 million in additional development milestone payments and up to $50.0 million in commercial milestone payments. In addition, upon commercialization of any product covered by the agreement, Takeda is required to pay us a quarterly royalty on net sales revenue on sales of the commercialized product.

 

Governance.  Our collaboration with Takeda is governed by several committees consisting of an equal number of representatives from both companies. These consist of a joint steering committee, which resolves any conflicts arising within the other committees, a joint development committee, a joint commercialization committee and a joint manufacturing committee. In the case of a deadlock within the joint steering committee, our chief executive officer has the determining vote on matters arising from the joint development and manufacturing committees, while Takeda’s representative has the determining vote on matters arising from the joint commercialization committee.

 

New Indications and Additional Territories.  Under the agreement, Takeda has a right of first refusal to obtain a license to develop and commercialize Amitiza in the United States and Canada for any new indications that we may develop. In addition, the agreement granted Takeda an option to exclusively negotiate with our affiliated European and Asian operating companies, Sucampo Pharma Europe Ltd., or Sucampo Europe, and Sucampo Pharma Ltd., or Sucampo Japan, to jointly develop and commercialize Amitiza in two additional territories: Europe, the Middle East, and Africa; and Asia. With respect to the negotiation rights for Europe, the Middle East and Africa, Takeda was required to pay Sucampo Europe an option fee of $3.0 million. In the event that these negotiations failed to produce a definitive agreement before we received marketing approval in the United States for Amitiza for the treatment of chronic idiopathic constipation in adults, Sucampo Europe was required to repay Takeda $1.5 million of the original option fee. With respect to the negotiation rights for Asia, Takeda was required to pay Sucampo Japan an option fee of $2.0 million. In the event that these negotiations failed to produce a definitive agreement within twelve months, Sucampo Japan was required to repay Takeda $1.0 million of the original option fee. By the first quarter of 2006, the option rights for both territories had expired without agreement and, accordingly, we repaid Takeda an aggregate of $2.5 million of the original option fees. The amounts we retained were recorded as contract revenue in the statements of operations when the negotiations failed and agreements expired.

 

Under the agreement, if we wish to use data or information developed under the collaboration with Takeda outside the United States or Canada, for example in support of a regulatory filing in Europe or Asia, we are obligated to pay to Takeda a one-time fee the first time such data or information is used in specified territories. The amount of the fee for each territory is to be agreed between us and Takeda. In February 2008, in connection with our MAA for lubiprostone in Europe, we agreed with Takeda to make a one-time payment of $1.8 million, which will permit us to use in Europe, the Middle East and Africa all data and information developed under the agreement relating to the use of lubiprostone to treat chronic idiopathic constipation.

 

Term.  The Takeda agreement continues until 2020 unless earlier terminated. We may terminate the agreement if Takeda fails to achieve specific levels of net sales revenue or if Takeda comes under the control of another party and launches a product competitive with Amitiza. Alternatively, either party has the right to terminate the agreement in the following circumstances:

 

 

Intellectual Property

 

Our success depends in part on our ability, and that of Sucampo AG, to obtain and maintain proprietary protection for the technology and know-how upon which our products are based, to operate without infringing on the proprietary rights of others and to prevent others from infringing on our proprietary rights.

 

We hold an exclusive worldwide royalty-bearing license from Sucampo AG to develop and commercialize Amitiza and other prostone compounds covered by patents and patent applications held by Sucampo AG. As of December 31, 2008, we had licensed from Sucampo AG rights to a total of 51 U.S. patents, 19 U.S. patent applications, 22 European patents, 14 European patent applications, 25 Japanese patents and 19 Japanese patent applications. Many of these patents and patent applications are counterparts of each other. Our portfolio of licensed patents includes patents or patent applications with claims directed to the composition of matter, including both compound and pharmaceutical formulation, or method of use, or a combination of these claims, for Amitiza, cobiprostone and SPI-017. Depending upon the timing, duration and specifics of FDA approval of the use of a compound for a specific indication, some of our U.S. patents may be eligible for limited patent term extension under the Drug Price Competition and Patent Term Restoration Act of 1984, referred to as the Hatch-Waxman Act.

 

The patent rights relating to Amitiza licensed by us consist of nine issued U.S. patents and five issued European patents relating to composition of matter and methods of use. These patent rights also include various U.S., European and Japanese patent applications relating to dosing, pharmaceutical formulation and other claims. The U.S. patents relating to composition of matter expire between 2014 and 2020. The other U.S. and foreign patents expire between 2009 and 2022.

 

The patent rights relating to cobiprostone licensed by us consist of ten issued U.S. patents, four issued European patents, and six issued Japanese patents relating to composition of matter and methods of use. These patent rights also include various U.S., European and Japanese patent applications relating to dosing regimens, pharmaceutical formulation and other claims. The U.S. patents relating to composition of matter expire between 2011 and 2020. The other U.S. and foreign patents expire between 2010 and 2022.

 

The patent rights relating to SPI-017 licensed by us consist of ten issued U.S. patents, six issued European patents and six issued Japanese patents relating to methods of use. These patent rights also include various U.S., European and Japanese patent applications relating to composition of matter and methods of use. The U.S. patent relating to composition of matter expires in 2021. The U.S. patents relating to methods of use and the other U.S. and foreign patents expire between 2010 and 2022.

 

In addition, we share joint ownership of eight U.S. patents with R-Tech. These patents cover prostone compounds, formulations and manufacturing methods.

 

We are actively seeking to augment the patent protection of our licensed compounds by focusing on the development of new chemical entities, or NCEs, such as Amitiza, cobiprostone and SPI-017, which have not previously received FDA approval. Upon approval by the FDA, NCEs are entitled to market exclusivity in the United States with respect to generic drug products for a period of five years from the date of FDA approval, even if the related patents have expired.

 

License from Sucampo AG

 

On June 30, 2006, we entered into a restated license agreement with Sucampo AG. Under this agreement, Sucampo AG has granted to us 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 Sucampo AG’s patents. Under the terms of the restated license agreement, which became effective upon our initial public offering in 2007, we are obligated to assign to Sucampo AG any patentable improvements derived or discovered by us relating to Amitiza, cobiprostone and SPI-017 through the term of the license. In addition, we are obligated to assign to Sucampo AG any patentable improvements derived or discovered by us relating to other licensed prostone compounds prior to the date which is the later of June 30, 2011 or the date on which Drs. Ueno and Kuno cease to control our company. For purposes of this agreement, Drs. Ueno and Kuno will be deemed to control our company as long as either they together own a majority of the voting power of our

stock or at least one of them is a member of our board of directors. All compounds assigned to Sucampo AG under this agreement will be immediately licensed back to us on an exclusive basis.

 

In consideration of the license, we are required to make milestone and royalty payments to Sucampo AG. The milestone payments include:

 

 

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, we are required to pay Sucampo AG 5% of any up-front or milestone payments that we receive from sublicensees.

 

Under the license and an addendum we entered in February 2009, we also are required to pay Sucampo AG, on a country-by-country basis, ongoing patent royalties as follows:

 

 

In addition, we are required to pay Sucampo AG, on a country-by-country basis, a know-how royalty of 1% of net sales in the case of sales of Amitiza in North, Central and South America, including the Caribbean, and Asia, Australia and New Zealand; and 2% of net sales in the case of sales of Amitiza in other territories or sales of other compounds, until the fifteenth anniversary of the first sale of the respective compound. All product royalties required to be paid under the license are based on total product net sales, whether by us or a sublicensee, and not on amounts actually received by us.

 

The license from Sucampo AG is perpetual as to Amitiza, cobiprostone and SPI-017 and cannot be terminated unless we default in our payment obligations to Sucampo AG. With respect to any other licensed prostone compounds, we are required to perform preclinical testing over a specified period on those compounds and to generate specified pharmacological and toxicity data. The specified period ends on the later of June 30, 2011 or the date upon which Drs. Ueno and Kuno no longer control our company. Following the end of the specified period, Sucampo AG can terminate our license with respect to any compounds as to which we have not performed the required testing, except for any compounds we designate as compounds for which we intend in good faith to perform the required testing within the 15 months following the end of the specified period. At the end of the 15-month extension period, Sucampo AG may terminate our license as to any of the designated compounds for which we have not performed the required testing.

 

We will need to focus our development resources and funding on a limited number of compounds during the specified period. The decision whether to commit development resources to a particular compound will require us to determine which compounds have the greatest likelihood of commercial success. Dr. Ueno and his staff will be

instrumental in making these decisions on our behalf, although to assist in this determination, we have formed a selection committee consisting of certain members of management other than Drs. Ueno and Kuno.

 

We retain the rights to any improvements, know-how or other intellectual property we develop that is not related to prostones. We also retain the rights to any improvements, know-how or other intellectual property we develop after the end of the specified period, even if they are related to prostones.

 

The agreement provides that, until the later to occur of June 30, 2011 or until Drs. Ueno and Kuno cease to control our company, Sucampo AG may not develop or commercialize:

 

 

Thereafter, Sucampo AG may undertake development of competing products but may not commercialize these products for an additional two years.

 

As part of this license, we have assumed the responsibility to pay the patent filing and maintenance costs related to the licensed rights. In return, we have control over patent filing and maintenance decisions. The license agreement also specifies how we and Sucampo AG will allocate costs to defend patent infringement litigation brought by third parties and costs to enforce patents against third parties. As of December 31, 2008, we have not incurred any cost relating to defending or enforcing patents against third parties.

 

Manufacturing

 

We do not own or operate manufacturing facilities for the production of commercial quantities of Amitiza or preclinical or clinical supplies of the other prostone compounds that we are testing in our development programs. Instead, we rely, and expect to continue to rely, exclusively on our affiliate R-Tech to supply us with Amitiza, cobiprostone and SPI-017 and any future prostone compounds that we determine to develop or commercialize. Drs. Ueno and Kuno own, directly and indirectly, a majority of the stock of R-Tech.

 

We have entered into an exclusive supply arrangement with R-Tech. Under the terms of this arrangement, we have granted to R-Tech the exclusive right to manufacture and supply Amitiza to us to meet our commercial and clinical requirements in the Americas, Europe, the Middle East and Africa until 2026. With the exception of the exclusive supply agreements with Takeda described below, R-Tech is prohibited from supplying Amitiza to anyone other than us during this period. Our supply arrangement with R-Tech also provides that R-Tech will assist us in connection with applications for marketing approval for Amitiza in the United States and elsewhere, including assistance with regulatory compliance for chemistry, manufacturing and controls. In consideration of these exclusive rights, R-Tech has paid to us $8.0 million in up-front and milestone payments as of December 31, 2008. Either we or R-Tech may terminate the supply arrangement with respect to us or Sucampo Europe in the event of the other party’s uncured breach or insolvency.

 

In anticipation of the commercial development of Amitiza, we entered into a 16-year supply agreement with Takeda and R-Tech in October 2004, which was supplemented by a definitive supply and purchase agreement in January 2006. Under these agreements, R-Tech agreed to supply and Takeda agreed to purchase all of Takeda’s commercial requirements, including product samples, for Amitiza in the United States and Canada. Pursuant to the terms of these agreements, Takeda is required to provide R-Tech with a rolling 24-month forecast of its product and sample requirements and R-Tech is required to keep adequate levels of inventory in line with this forecast. In addition, these agreements require R-Tech to maintain a six-month supply of the active ingredient used in manufacturing Amitiza and a six-month supply of Amitiza in bulk form as backup inventory. Upon a termination of the collaboration and license agreement between Takeda and us, either Takeda or we may terminate these supply agreements by notice to R-Tech.

 

On February 23, 2009, we entered into an Exclusive Manufacturing and Supply Agreement with R-Tech under which we granted R-Tech the exclusive right to manufacture and supply lubiprostone to meet our commercial and clinical requirements in Asia, Australia and New Zealand. In consideration, R-Tech will make an up-front payment of $250,000 and will be obligated to make milestone payments of $500,000 upon regulatory approval of

lubiprostone in Japan and $250,000 upon the commercial launch in Japan. In addition, R-Tech is required to maintain at least a six-month supply of lubiprostone and a three-month supply of the active ingredient used in manufacturing lubiprostone as a backup inventory.

 

R-Tech is Takeda’s and our sole supplier of Amitiza. In the event that R-Tech cannot meet some or all of Takeda’s or our demand, neither Takeda nor we have alternative manufacturing arrangements in place. However, R-Tech has agreed to maintain at least a six-month supply of Amitiza and a six-month supply of the active ingredient used in manufacturing Amitiza as a backup inventory. R-Tech may draw down this backup inventory to supply Amitiza to us in the event that R-Tech is unable or unwilling to produce Amitiza to meet our demand. We also have the right to qualify a back-up supplier for Amitiza. In the event that R-Tech is unwilling or unable to meet our demand, R-Tech will grant to that back-up supplier a royalty-free license to use any patents or know-how owned by R-Tech relating to the manufacturing process for Amitiza and will provide, upon our reasonable request and at our expense, consulting services to the back-up supplier to enable it to establish an alternative manufacturing capability for Amitiza. We may purchase Amitiza from the back-up supplier until R-Tech is able and willing to meet our demand for Amitiza.

 

R-Tech operates a manufacturing facility near Osaka, Japan that we believe is compliant with current good manufacturing practices, or cGMP. R-Tech received approval from the FDA in October 2005 and from the Medicines and Healthcare Products Regulatory Agency or MHRA in October 2008 to manufacture Amitiza at this facility. In addition, R-Tech manufactures its own prostone product Rescula at this facility and has been the sole supplier of this product to the marketplace since 1994 without interruption.

 

We have also entered into an exclusive supply arrangement with R-Tech to provide us with clinical supplies of our product candidates cobiprostone and SPI-017, as well as any other prostone compound we may designate, and to assist us in connection with applications for marketing approval for these compounds in the United States and elsewhere, including assistance with regulatory compliance for chemistry, manufacturing and controls. This clinical supply arrangement has a two year term which renews automatically for one-year periods unless we and R-Tech agree not to renew it. Either we or R-Tech may terminate the clinical supply arrangement with respect to us or one of our operating subsidiaries in the event of the other party’s uncured breach or insolvency.

 

Competition

 

The biotechnology and pharmaceutical industries are characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary products. While we believe that our technologies, knowledge, experience and resources provide us with competitive advantages, we face potential competition from many different sources, including commercial pharmaceutical and biotechnology enterprises, academic institutions, government agencies, and private and public research institutions. Amitiza and any other product candidates that we successfully develop and commercialize will compete with existing therapies and new therapies that may become available in the future.

 

There are currently approved therapies for the diseases and conditions addressed by Amitiza. For example, the osmotic laxatives MiraLax, which is marketed by Braintree Laboratories, Inc., and lactulose, which is produced by Solvay S.A., have each been approved for the short-term treatment of occasional constipation. MiraLax was recently approved for sale as an over-the-counter treatment.

 

Several companies also are working to develop new drugs and other therapies for these same diseases and conditions. Some of these potential competitive drug products include:

 

 

 

We face similar competition from approved therapies and potential drug products for the diseases and conditions to be addressed by cobiprostone, SPI-017 and our other product candidates. The current standard of care for NSAID induced ulcers is the usage of PPI medications.

 

The key competitive factors affecting the success of all of our product candidates are likely to be their efficacy, safety, price and convenience.

 

Government Regulation

 

Government authorities in the United States, at the federal, state and local level, and in other countries extensively regulate, among other things, the research, development, testing, approval, manufacturing, labeling, post-approval monitoring and reporting, packaging, promotion, storage, advertising, distribution, marketing and export and import of pharmaceutical products such as those we are developing. The process of obtaining regulatory approvals and the subsequent compliance with appropriate federal, state, local and foreign statutes and regulations require the expenditure of substantial time and financial resources.

 

United States Government Regulation

 

In the United States, the FDA regulates drugs under the Federal Food, Drug, and Cosmetic Act, as amended, and it’s implementing regulations. The FDA has jurisdiction over all of our products and administers requirements covering the safety, effectiveness, manufacturing, quality control distribution, labeling, marketing, advertising, dissemination of information and post-marketing study and surveillance of our pharmaceutical products. Information that must be submitted to the FDA in order to obtain approval to market a drug varies depending upon whether the drug is a new product whose safety and efficacy have not previously been demonstrated in humans or a drug whose active ingredients and certain other properties are the same as those of a previously approved drug. The results of product development, preclinical studies and clinical trials must be submitted to the FDA as part of the approval process. The FDA may deny approval if the applicable regulatory criteria are not satisfied, or it may require additional clinical data or an additional pivotal phase III clinical trial. Even if such data are submitted, the FDA may ultimately decide that the application does not satisfy the criteria for approval.

 

Obtaining FDA approval for new products and manufacturing processes can take a number of years and involve the expenditure of substantial resources. To obtain FDA approval for the commercial sale of a therapeutic agent, the potential product must undergo testing programs on animals, the data from which is used to file an IND with the FDA. In addition, there are three phases of human testing:

 

 

The data from these tests is combined with data regarding chemistry, manufacturing and animal toxicology and is then submitted in the form of a New Drug Application, or NDA, to the FDA. The preparation of an NDA requires the expenditure of substantial funds and the commitment of substantial resources.

Failures to comply with the applicable FDA requirements at any time during the product development process, approval process or after approval may result in administrative or judicial sanctions. These sanctions could include the FDA’s imposition of a hold on clinical trials, refusal to approve pending applications, withdrawal of an approval, warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties or criminal prosecution. Any agency or judicial enforcement action could have a material adverse effect on us.

 

The FDA extensively regulates all aspects of manufacturing quality under its current good manufacturing practices (cGMP) regulations. The FDA inspects the facility or the facilities at which drug products are manufactured. The FDA will not approve the product unless cGMP compliance is satisfactory. If the FDA determines the application, manufacturing process or manufacturing facilities, are not acceptable, it will outline the deficiencies in the submission and often will request additional testing or information.

 

The testing and approval process requires substantial time, effort and financial resources, and each may take several years to complete. Data obtained from clinical activities are not always conclusive and may be susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. The FDA may not grant approval on a timely basis, or at all. We may encounter difficulties or unanticipated costs in our efforts to secure necessary governmental approvals, which could delay or preclude us from marketing our products. The FDA may limit the indications for use or place other conditions on any approvals that could restrict the commercial application of the products. After approval, some types of changes to the approved product, such as manufacturing changes and additional labeling claims, are subject to further FDA review and approval.

 

Post-Approval Requirement

 

After regulatory approval of a product is obtained, we are required to comply with a number of post-approval requirements. For example, the FDA may require post marketing, or phase 4, trials to assess the product’s long-term safety or efficacy. In addition, holders of an approved NDA are required to report certain adverse drug reactions and production problems to the FDA, to provide updated safety and efficacy information and to comply with requirements concerning advertising and promotional labeling for their products. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes certain fiscal, procedural, substantive and recordkeeping requirements.

 

We rely, and expect to continue to rely, on third parties for the production of clinical and commercial quantities of our product candidates. Future FDA inspections may identify compliance issues at our facilities or at the facilities of our contract manufacturers that may disrupt production or distribution, or require substantial resources to correct. In addition, discovery of problems with a product or the failure to comply with applicable requirements may result in restrictions on a product, manufacturer or holder of an approved NDA, including withdrawal or recall of the product from the market or other voluntary, FDA-initiated or judicial action that could delay or prohibit further marketing. Newly discovered or developed safety or effectiveness data may require changes to a product’s approved labeling, including the addition of new warnings, precautions and contraindications. Also, new government requirements, including those resulting from new legislation, may be established that could delay or prevent regulatory approval of our products under development.

 

Regulation Outside the United States

 

In addition to regulations in the United States, we are subject to a variety of regulations in other jurisdictions most notably by the European Medicines Agency in the European Union and the Ministry of Health, Labor and Welfare in Japan. Whether or not we obtain FDA approval for a product, we must obtain approval of a product by the comparable regulatory authorities of countries outside the United States before we can commence clinical trials or marketing of the product in those countries The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary greatly from country to country, and the time for approval may be longer or shorter than that required by the FDA.

Europe

 

In Europe medicinal products are governed by a framework of European Union regulations which apply across all European Union member states. To obtain regulatory approval of a drug under the European Union regulatory system, we may submit marketing authorizations either under a centralized or decentralized procedure. The centralized procedure, which is compulsory for medicines produced by certain biotechnological processes and optional for those which are innovative, provides for the grant of a single marketing authorization that is valid for all European Union member states. The decentralized procedure provides for a member state, known as the reference member state, to assess an application, with one or more other, or concerned, member states subsequently approving that assessment. The European Union also governs among other areas, the authorization and conduct of clinical trials, the marketing authorization process for medical products, manufacturing and import activities, and post-authorization activities including pharmacovigilance. The European Union has established new regulations on pediatric medicines which impose certain obligations on pharmaceutical companies with respect to the investigation of their products in children.

 

Sucampo’s wholly owned subsidiary, Sucampo Pharma Europe Ltd., located in Oxford, UK and Basel, Switzerland is subject to a number of regulatory requirements and inspection by the authorities. The Basel office was inspected in 2008 for compliance with applicable licenses and permits.

 

Japan

 

In Japan, pre-marketing approval and clinical studies are required for all pharmaceutical products. The regulatory regime for pharmaceuticals in Japan has in the past been so lengthy and costly that it has been cost-prohibitive for many pharmaceutical companies. Historically, Japan has required that all clinical data submitted in support of a new drug application be performed on Japanese patients. Recently, however, as a part of the global drug harmonization process, Japan has signaled a willingness to accept United States or European Union patient data when submitted along with a bridging study, which demonstrates that Japanese and non-Japanese subjects react comparably to the product. This approach, which is executed on a case-by-case basis, may reduce the time required for approval and introduction of new products into the Japanese market.

 

Regulation of the Health Care Industry

 

In addition to the regulatory approval requirements described above, we are or will be directly or indirectly through our customers, subject to extensive regulation of the health care industry by the federal and state government and foreign countries in which we may conduct our business. The laws that directly or indirectly affect our ability to operate our business include the following:

 

 

If our operations are found to be in violation of any of these laws, regulations, rules or policies or any other law or governmental regulation, or if interpretations of the foregoing change, we may be subject to civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations.

 

Pharmaceutical Pricing and Reimbursement

 

In the United States and markets in other countries, sales of any products for which we receive regulatory approval for commercial sale will depend in part on the availability of reimbursement from third-party payors. Third-party payors include government health administrative authorities, managed care providers, private health insurers and other organizations. These third-party payors are increasingly challenging the price and examining the cost-effectiveness of medical products and services. In addition, significant uncertainty exists as to the reimbursement status of newly approved healthcare product candidates. We may need to conduct expensive pharmacoeconomic studies in order to demonstrate the cost-effectiveness of our products. Our product candidates may not be considered cost-effective. Adequate third-party reimbursement may not be available to enable us to maintain price levels sufficient to realize an appropriate return on our investment in product development.

 

Federal, state and local governments in the United States continue to consider legislation to limit the growth of healthcare costs, including the cost of prescription drugs. Future legislation could limit payments for pharmaceuticals, and the drug candidates that we are developing.

 

Another development that may affect the pricing of drugs is proposed Congressional action regarding drug re-importation into the United States. Proposed legislation would allow the re-importation of approved drugs originally manufactured in the United States back into the United States from other countries where the drugs are sold at a lower price. If such legislation or similar regulatory changes were enacted, they could reduce the price we receive for any approved products, which, in turn, could adversely affect our revenues.

 

Different pricing and reimbursement schemes exist in other countries. In the European Union, governments influence the price of pharmaceutical products through their pricing and reimbursement rules and control of national health care systems that fund a large part of the cost of such products to consumers. The approach taken varies from member state to member state. Some jurisdictions permit products to be marketed only after a reimbursement price has been agreed. Other member states allow companies to fix their own prices for medicines, but monitor and control company profits.

 

In Japan, the National Health Ministry biannually reviews the pharmaceutical prices of individual products. In the past, these reviews have resulted in price reductions. We expect similar price reviews in the future, in line with the government’s previously announced plan for controlling health care costs. It is not possible to predict the outcome of these reviews, and it is possible that Japanese authorities will again reduce drug reimbursement rates, which could adversely affect the reimbursement levels for our products or product candidates.

 

Executive Officers

 

The following table lists our executive officers and their ages as of March 5, 2009.

 

 

Ryuji Ueno, M.D., Ph.D., Ph.D.  Dr. Ueno is a founder of our company and has been our Chief Executive Officer since September 2006 and our Chief Scientific Officer since August 2004. Dr. Ueno also became the Chairman of our Board of Directors effective June 1, 2007 following the resignation of Dr. Sachiko Kuno from that position. Dr. Ueno also served as Chief Operating Officer from December 1996 to November 2000 and again from March 2006 to September 2006 and as Chief Executive Officer from December 2000 to September 2003. Dr. Ueno

has been a director since 1996 and served as Chairman of our Board of Directors from December 2000 to September 2006. Dr. Ueno co-founded our affiliate R-Tech in September 1989 and served as its President from 1989 to March 2003. Dr. Ueno also co-founded Sucampo AG in December 1997 and served as its Chairman of the Board or Vice Chairman of the Board since its inception. Dr. Ueno received his M.D. and a Ph.D. in medical chemistry from Keio University in Japan, and he received a Ph.D. in Pharmacology from Osaka University. Dr. Ueno is married to Dr. Sachiko Kuno, one of our founders and a member of our board of directors.

 

Jan Smilek.  Mr. Smilek joined us in February 2008 as Vice President of Finance and Corporate Controller. He was subsequently promoted to Acting Chief Financial Officer in August 2008 and to Chief Financial Officer in December 2008. Prior to joining our company, he was the Senior Director of Finance at Vanda Pharmaceuticals beginning in January 2006. Before that, he was Senior Director of Financial Reporting, Analysis and General Accounting at McGraw-Hill Companies from January 2005 to January 2006. He also worked at PricewaterhouseCoopers, LLP for 13 years beginning in 1991 in Prague, Miami and Washington, D.C. Mr. Smilek is a Certified Public Accountant in the United States, and is a graduate of the School of Economics, Bratislava, Slovakia and holds an International Executive M.B.A. degree from Georgetown University, McDonough School of Business.

 

Gayle R. Dolecek.  Dr. Dolecek has been our Senior Vice President of Research and Development since May 2006. From August 1995 to April 2006, he was a Senior Consultant at AAC Consulting Group, Inc., a provider of regulatory consulting services to the pharmaceutical industry. Prior to 1995, Dr. Dolecek was an officer with the U.S. Public Health Service where he served in pharmacy and health service related positions. He completed his career with the government in the Food and Drug Administration as Director of Compendial Operations in the Center for Drug Evaluation and Research. Dr. Dolecek received his B.S./P.D. in Pharmacy from the University of Maryland and a M.P.H. in Health Services and Planning from the University of Hawaii.

 

Stanley G. Miele.  Mr. Miele has been our Senior Vice President since October 2008. Prior to his new role, he was our Vice President of Sales and National Director of Sales since February 2006. Prior to joining Sucampo, Mr. Miele, as a Sales Director, managed a national level team of specialty sales representatives and engineering consultants that sold and marketed blood gas analyzers and point of care diagnostic equipment used in acute-care areas within hospitals at Abbott Point of Care beginning October 2005. Prior to that, Mr. Miele held a series of positions at Millennium Pharmaceuticals (and COR Therapeutics prior to its acquisition by Millennium) including National Sales Director, Cardiology where he was responsible for managing the overall hospital-based cardiovascular sales function beginning January 2003. Previously, Mr. Miele was a Division Sales Representative with Abbott Labs’ Hospital Products Division, of Abbott Park, Illinois, and a Sales Representative for Syntex Labs, of Palo Alto, California. Mr. Miele earned a B.A. in Management/Communications from the University of Dayton.

 

Employees

 

As of March 5, 2009, we had 94 full-time employees, including 34 with doctoral or other advanced degrees. Of our workforce, 30 employees are engaged in research and development, 39 are engaged in sales and marketing and 25 are engaged in business development, legal, finance and administration. None of our employees are represented by a labor union or covered by collective bargaining agreements. We have never experienced a work stoppage and believe our relationship with our employees is good.

 

Our Dual Class Capital Structure

 

We have two classes of common stock authorized; class A common stock and class B common stock. Holders of class A common stock and class B common stock have identical rights, except that holders of class A common stock are entitled to one vote per share and holders of class B common stock are entitled to ten votes per share on all matters on which stockholders are entitled to vote.

 

As of March 5, 2009, we had outstanding 15,651,849 shares of class A common stock and 26,191,050 shares of class B common stock. The class B common stock represents approximately 95% of the combined voting power of our outstanding common stock. All of the shares of class B common stock are owned by S&R Technology Holding, LLC, or S&R, an entity wholly-owned by our founders, Drs. Ueno and Kuno. As a result, Drs. Ueno and Kuno will be able to control the outcome of all matters upon which our stockholders vote, including the election of directors, amendments to our certificate of incorporation and mergers or other business combinations.

We are not authorized to issue additional shares of class B common stock except in limited circumstances, such as a stock split of both classes of common stock or a stock dividend made in respect of both classes of common stock. Shares of class B common stock will automatically be converted into shares of class A common stock upon transfer, with limited exceptions for transfers to family trusts. In addition, all remaining outstanding shares of class B common stock will automatically be converted into shares of class A common stock upon the death, legal incompetence or retirement from our company of both Drs. Ueno and Kuno or at such time as the number of outstanding shares of class B common stock is less than 20% of the number of outstanding shares of class A and class B common stock together.

 

In this report, we refer to our authorized class A common stock and class B common stock together as our common stock.

 

Our Corporate Information

 

Our predecessor was incorporated under the laws of Delaware in December 1996.

 

In December 2008, we implemented a new holding company structure. In this reorganization, Sucampo Pharmaceuticals, Inc. became a wholly owned subsidiary of a newly formed Delaware holding company, then known as Sucampo Pharma Holdings, Inc., which became the publicly traded company. Each share of Sucampo Pharmaceuticals, Inc. stock was automatically converted into equivalent shares of the holding company with the same rights and privileges as the converted shares.

 

Immediately after the reorganization, Sucampo Pharmaceuticals, Inc. was renamed Sucampo Pharma Americas, Inc. and the holding company succeeded to the name Sucampo Pharmaceuticals, Inc. Sucampo Pharma Americas, Inc. then distributed to the new holding company the stock of its two wholly owned subsidiaries, Sucampo Pharma Ltd. and Sucampo Pharma Europe Ltd. As a result, those two companies are now also wholly owned subsidiaries of the new holding company.

 

The final corporate structure consists of a public holding company named Sucampo Pharmaceuticals, Inc., which has three wholly owned subsidiaries: Sucampo Pharma Ltd., based in Tokyo and Osaka, Japan, in which we conduct our Asian operations; Sucampo Pharma Americas, Inc., based in Bethesda, Maryland, in which we conduct operations in North and South America; and Sucampo Pharma Europe Ltd., based in Oxford, U.K., and Basel, Switzerland, in which we conduct operations in Europe and the rest of the world.

 

Our principal executive offices are located at 4520 East-West Highway, Suite 300, Bethesda, Maryland 20814, and our telephone number is (301) 961-3400.

 

Website Access to U.S. Securities and Exchange Commission Reports

 

Our Internet address is http://www.sucampo.com. Through our website, we make available, free of charge, access to all reports filed with the U.S. Securities and Exchange Commission, or the SEC, including our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and amendments to these reports, as filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Copies of any materials we file with, or furnish to, the SEC can also be obtained free of charge through the SEC’s website at http://www.sec.gov or at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

 

In addition to the other information set forth in this report, the following factors should be considered carefully in evaluating our business and our company.

 

Risk Related to Current Worldwide Economic Downturn

 

The recent downturn in the global economy and the recent pressure on capital markets increases the possibility of and may exacerbate the impact of any adverse effects on our financial position and business prospects.

 

The recent downturn in the U.S. economy and economies around the world and the extraordinary pressure being placed on both debt and equity markets have led to significant retraction in U.S. businesses, sudden and severe decreases in the prices of U.S. equities generally and a severe shortage in available credit. These factors have made it more difficult, in general, for companies to expand or maintain their current operations and have increased the likelihood that companies will fail. Although we cannot say with certainty the impact the current economic crises has had on us to date or may have on us in the future, continued pressure on the U.S. economy and its capital markets may have the effect of, among other things, reducing demand for Amitiza and other medicines, imposing significant pricing pressure, compromising the ability of our collaborators to timely satisfy their performance obligations, increasing the cost to manufacture our products, or making it more difficult for us to raise capital or enter into strategic relationships, each of which could hurt our business and business prospects. If the economic downturn in foreign economies is prolonged, this could harm our ability to pursue our strategy of developing and commercializing Amitiza and other compounds in Europe, Japan and other territories. The economic downturn may also lead to, or accelerate, a decrease in the trading price of our class A common stock.

 

We recently implemented a cost saving initiative by reducing our headcount and refocusing our research and development plans and our sales and marketing efforts.

 

To conserve cash and more closely align our spending towards our strategic objectives, we implemented a cost reduction initiative in early 2009, including a workforce reduction in our administrative, research and development and sales and marketing staffs and a refocusing of our research and development plans. These reductions could make it more difficult to manage our business and might compromise our ability to pursue our development and commercialization strategies.

 

Risks Related to Our Limited Commercial Operations

 

Although we reported profit for three consecutive years ending December 31, 2008, we may not maintain operating profitability in the future.

 

We initiated commercial sales of our first product, Amitiza, for the treatment of chronic idiopathic constipation in adults in April 2006 and for the treatment of irritable bowel syndrome with constipation in May 2008 and we first generated product royalty revenue in the quarter ended June 30, 2006. Although we had net income of $25.0 million in 2008 and our retained earnings turned positive to $14.8 million in 2008 as compared to $10.2 million deficit in 2007, this was primarily attributable to our development milestones of $50.0 million and $30.0 million earned in 2008 and 2007, respectively. Our primary cost drivers result from expenses incurred in our research and development programs and from our general and administrative expenses. We expect to continue to incur significant and increasing expenses for at least the next several years as we continue our research activities and conduct development of, and seek regulatory approvals for, additional indications for Amitiza and for other drug candidates. Whether we are able to achieve sustainable operating profitability in the future will depend upon our ability to generate revenues that exceed our expenses. Changes in market conditions, including the failure or approval of competing products, may require us to incur more expenses or change the timing of expenses such that we may incur unexpected losses. We may not be able to sustain or increase profitability on a quarterly or annual basis. If we are unable to maintain profitability, the market value of our class A common stock may decline.

If we are unable to continue successful commercialization of our first product, Amitiza, for the treatment of chronic idiopathic constipation in adults and irritable bowel syndrome with constipation and other indications for which we are developing this drug, or experience significant delays in doing so, our ability to generate product-based revenues and achieve profitability will be jeopardized.

 

In the near term, our ability to increase product-based revenues will depend on the continued growth in commercialization and continued development of Amitiza. The growth in sale of Amitiza will depend on several factors, including the following:

 

 

If we are not successful in maintaining continued growth in commercializing Amitiza or are significantly delayed in doing so, our business will be materially harmed.

 

We have limited experience commercializing drug products. If we are not successful in maintaining the transition from a pre-commercial stage company to a commercial company, our ability to continue profitability will be compromised.

 

For most of our operating history, we have been a pre-commercial stage company. Our operations to date have been limited largely to organizing and staffing our company, developing prostone technology, undertaking preclinical and clinical trials of our product candidates and coordinating the U.S. regulatory approval process for Amitiza. To make the transition to a commercial company, we will need to continue to develop internally, or contract with third parties to provide us with, the capabilities to manufacture a commercial scale product and to conduct the sales and marketing activities necessary for successful product commercialization. While we are currently utilizing R-Tech to perform these manufacturing functions and Takeda to perform many of these sales and marketing functions with respect to the sale of Amitiza in the United States, we may nevertheless encounter unforeseen expenses, difficulties, complications and delays as we establish these commercial functions for Amitiza and for other products for which we may receive regulatory marketing approval. As we continue to develop and seek regulatory approval of additional product candidates and additional indications for Amitiza, and to pursue regulatory approvals for Amitiza and other products outside the United States, it could be difficult for us to obtain and devote the resources necessary to successfully manage our commercialization efforts. If we are not successful in completing our transition to a commercial company, our ability to remain profitable will be jeopardized and the market price of our class A common stock is likely to decline.

 

Risks Related to Employees and Managing Growth

 

If we are unable to retain our chief executive and chief scientific officer and other key executives, we may not be able to successfully develop and commercialize our products.

 

We are highly dependent on Dr. Ryuji Ueno, our chief executive officer and chief scientific officer, and the other principal members of our executive and scientific teams, including Jan Smilek, our chief financial officer, Stanley Miele, our senior vice president of sales and marketing and Gayle Dolecek, our senior vice president of

research and development. The loss of the services of any of these persons might impede the achievement of our product development and commercialization objectives and it might be difficult to recruit a replacement executive for any of their positions. We have employment agreements with these executives, but these agreements are terminable by the employees on short or no notice at any time without penalty to the employee. We do not maintain key-man life insurance on any of our executives.

 

If we fail to attract, retain and motivate qualified personnel, we may not be able to pursue our product development and commercialization programs.

 

Recruiting and retaining qualified scientific and commercial personnel, including clinical development, regulatory, and marketing and sales executives and field personnel, will be critical to our success. If we fail to recruit and then retain these personnel, our ability to pursue our clinical development and product commercialization programs will be compromised. We may not be able to attract and retain these personnel on acceptable terms given the competition among numerous pharmaceutical and biotechnology companies for similar personnel. We also experience competition for the hiring of scientific personnel from universities and research institutions.

 

We may encounter difficulties in managing growth, which could disrupt our operations.

 

To manage future growth in our business, we must continue to implement and improve our managerial, operational and financial systems, expand our facilities, and continue to recruit and train additional qualified personnel. This may become more challenging as a result of our recent headcount reductions, which affected our administrative staff. Due to our limited resources, we may not be able to effectively manage any expansion of our operations or recruit and train additional qualified personnel. Expansion of our operations could lead to significant costs and might divert our management and business development resources. The challenges of managing our growth will become more significant as we expand the operations of Sucampo Europe and Sucampo Japan. Any inability to manage growth could delay the execution of our business plans or disrupt our operations.

 

The requirements of being a public company may strain our resources and distract management.

 

We completed our initial public offering in August 2007. As a public company, we will incur significant legal, accounting, corporate governance and other expenses that we did not incur as a private company. We are subject to the requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, The NASDAQ Global Market, and other rules and regulations. These rules and regulations may place a strain on our systems and resources. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition. Sarbanes-Oxley requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. The first time that we and our external auditors were required to issue a report on the design and operating effectiveness of our internal controls over financial reporting was as of December 31, 2008. We currently do not have an internal audit group. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal controls over financial reporting, we will need to devote significant resources and management oversight. As a result, management’s attention may be diverted from other business concerns. In addition, we might need to hire additional accounting staff with appropriate public company experience and technical accounting knowledge and we cannot assure you that we would be able to do so in a timely fashion. These strains may become more acute as a result of our recent headcount reductions, which affected our administrative and accounting staff.

 

The rules and regulations applicable to us as a public company may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers.

 

We may experience material weaknesses in our internal controls over financial reporting, which could result in delays of our public filings and be costly to correct.

 

We have in the past identified material weaknesses in our internal controls over financial reporting. Although we have remediated these material weaknesses, if we identify other material weaknesses in the future and are unable

to remediate them, we may not be able to accurately and timely report our financial position, results of operations or cash flows as a public company. Becoming subject to the public reporting requirements of the Securities Exchange Act upon the completion of the initial public offering intensified the need for us to report our financial position, results of operations and cash flows on an accurate and timely basis. If we are not able to prepare complete and accurate financial statements on a timely basis, this could result in delays in our public filings and ultimately delisting of our class A common stock from its principal trading market.

 

Risks Related to Product Development and Commercialization

 

Commercial rights to some prostone compounds will revert back to Sucampo AG in the future unless we devote sufficient development resources to those compounds during the next several years; if any of the compounds that revert back to Sucampo AG subsequently become valuable compounds, we will have lost the commercial rights to those compounds and will not be able to develop or market them, and the reverted compounds could ultimately compete with compounds we are developing or marketing.

 

Sucampo AG has granted to us an exclusive worldwide license to develop and commercialize products based upon Sucampo AG’s extensive portfolio of U.S. and foreign patents and patent applications relating to prostone technology. To retain our license rights to any prostone compounds other than Amitiza, cobiprostone and SPI-017, which are perpetual, we are required to perform preclinical testing over a specified period on those compounds and to generate specified pharmacological and toxicity data. The specified period ends on the later of June 30, 2011 or the date upon which Drs. Ueno and Kuno no longer control our company. For purposes of this agreement, Drs. Ueno and Kuno will be deemed to control our company as long as either they together own a majority of the voting power of our stock or at least one of them is a member of our board of directors. Following the end of the specified period, Sucampo AG can terminate our license with respect to any compounds as to which we have not performed the required testing, except for any compounds we designate as compounds for which we intend in good faith to perform the required testing within 15 months following the expiration of the specified period. At the end of that 15-month period, Sucampo AG may terminate our license as to any of the designated compounds for which we have not performed the required testing. Dr. Ueno and his wife, Dr. Kuno, indirectly own all the stock of Sucampo AG.

 

We will need to focus our development resources and funding on a limited number of compounds during the specified period. The decision whether to commit development resources to a particular compound will require us to determine which compounds have the greatest likelihood of commercial success. Dr. Ueno and his staff will be instrumental in making these decisions on our behalf, although to assist in this determination, we have formed a selection committee consisting of certain members of management that exclude Drs. Ueno and Kuno. In this process, we will likely commit resources to some compounds that do not prove to be commercially feasible and we may overlook other compounds that later prove to have significant commercial potential. If we do not identify and commit resources to one of these valuable compounds, the commercial rights with respect to the compound will eventually revert back to Sucampo AG. After the reversion of these rights to Sucampo AG, we will have no ability to develop or commercialize the compound. Although Sucampo AG will be prohibited from developing products that compete with our products prior to the end of the specified period, thereafter they will be free to develop competitive products. In addition, although Sucampo AG will be prohibited from marketing products that compete with our products for 24 months after the end of the specified period, after that date Sucampo AG will be permitted to market products, including products covered by the reverted license rights, in competition with us.

 

If our preclinical studies do not produce successful results or if our clinical trials do not demonstrate safety and efficacy in humans, our ability to develop additional indications for Amitiza and to develop and commercialize other product candidates will be impaired.

 

Before obtaining regulatory approval for the sale of our product candidates, we must conduct extensive preclinical tests and clinical trials to demonstrate the safety and efficacy in humans of our product candidates. Preclinical and clinical testing is expensive, is difficult to design and implement, can take many years to complete and is uncertain as to outcome. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and interim results of a clinical trial do not necessarily predict final results. A failure of one or more of our clinical trials can occur at any stage of testing. We may experience numerous

unforeseen events during, or as a result of, preclinical testing and the clinical trial process that could delay or prevent our ability to receive regulatory approval or commercialize our product candidates, including:

 

 

If we are required to conduct additional clinical trials or other testing of our product candidates beyond those that we currently contemplate, if we are unable to successfully complete our clinical trials or other testing or if the results of these trials or tests are not positive or are only modestly positive, we may:

 

 

Our product development costs will also increase if we experience delays in testing or approvals. We do not know whether our clinical trials will begin as planned, will need to be restructured or will be completed on schedule, if at all. Significant clinical trial delays also could allow our competitors to bring products to market before we do and impair our ability to commercialize our products or product candidates.

 

We are required to conduct supplemental post-marketing clinical trials of Amitiza and we may elect to perform additional clinical trials for other indications or in support of applications for regulatory marketing approval in jurisdictions outside the United States. These supplemental trials could be costly and could result in findings inconsistent with or contrary to our historic U.S. clinical trials.

 

In connection with our marketing approval for Amitiza for the treatment of chronic idiopathic constipation in adults, we committed to the FDA to conduct post-marketing studies of the product in pediatric patients, in patients with renal impairment and in patients with hepatic impairment. In the future, we may be required, or we may elect, to conduct additional clinical trials of Amitiza. In addition, if we seek marketing approval from regulatory

authorities in jurisdictions outside the United States, such as the European Medicines Agency, they may require us to submit data from supplemental clinical trials in addition to data from the clinical trials that supported our U.S. filings with the FDA. Any requirements to conduct supplemental trials would add to the cost of developing our product candidates. Additional or supplemental trials could also produce findings that are inconsistent with the trial results we have previously submitted to the FDA, in which case we would be obligated to report those findings to the FDA. This could result in new restrictions on Amitiza’s existing marketing approval or could force us to stop selling Amitiza altogether. Inconsistent trial results could also lead to delays in obtaining marketing approval in the United States for other indications for Amitiza or for other product candidates, could cause regulators to impose restrictive conditions on marketing approvals and could even make it impossible for us to obtain marketing approval. Any of these results could materially impair our ability to generate revenues and to achieve or maintain profitability.

 

If we are unable to establish sales and marketing capabilities or successfully use third parties to market and sell our products, we may be unable to generate sufficient product revenues to become profitable.

 

We currently have limited sales and distribution capabilities and little experience in marketing and selling pharmaceutical products. To achieve commercial success for Amitiza and any other approved products, we must either further develop our internal sales and marketing organization or continue to outsource these functions to third parties. There are risks associated with either of these alternatives. For example, expanding a sales force would be expensive and time consuming and could delay any product launch. If the commercial launch of a product for which we recruit a sales force and establish marketing capabilities were delayed, we would incur related expenses too early relative to the product launch. This may be costly, and our investment would be lost if we could not retain our sales and marketing personnel.

 

We have entered into a joint collaboration and license agreement with Takeda for the commercialization of Amitiza for gastrointestinal indications in the United States and Canada. Takeda markets Amitiza to office-based specialty physicians and primary care physicians in the United States. The Takeda sales force dedicated to selling Amitiza is significantly larger than our internal sales force, and we are therefore heavily dependent on the marketing and sales efforts of Takeda. If our internal sales force is not effective, or if Takeda is less successful in selling Amitiza than we anticipate, our ability to generate revenues and achieve profitability will be significantly compromised. We have also entered into an agreement with Abbott for the development and commercialization of lubiprostone to treat chronic idiopathic constipation in Japan and we are currently negotiating with Abbott to expand their territory to other parts of the world. If we achieve regulatory approval for lubiprostone in Japan or other countries where Abbott has rights to commercialization our compounds, we will be dependent upon their marketing and sales efforts.

 

We face substantial competition which may result in others discovering, developing or commercializing products earlier or more successfully than we do.

 

The development and commercialization of pharmaceutical products is highly competitive. We expect to face intense competition with respect to Amitiza and our other product candidates from major pharmaceutical companies, specialty pharmaceutical companies and biotechnology companies worldwide. Potential competitors also include academic institutions, government agencies, and other public and private research organizations that conduct research, seek patent protection and establish collaborative arrangements for research, development, manufacturing and commercialization. Our competitors may develop products that are safer, more effective, have fewer side effects, are more convenient or are less costly than Amitiza or the other product candidates that we are developing or that would render Amitiza or our other product candidates obsolete or uncompetitive. Our competitors may also obtain FDA or other regulatory approval for their products more rapidly than we may obtain approval for ours or achieve product commercialization before we do. A competitive product might become more popular if it is approved for sale over the counter. If any of our competitors develops a product that is more effective, safer or more convenient for patients, or is able to obtain FDA approval for commercialization before we do, we may not be able to achieve market acceptance for our products, which would impair our ability to generate revenues and recover the substantial developments costs we have incurred and will continue to incur.

There are currently approved therapies for the diseases and conditions addressed by Amitiza. For example, the osmotic laxatives MiraLax, which is marketed by Braintree Laboratories, Inc., and lactulose, which is produced by Solvay S.A., have each been approved for the short-term treatment of occasional constipation. MiraLax was recently approved for sale as an over-the-counter treatment.

 

Several companies also are working to develop new drugs and other therapies for these same diseases and conditions. Some of these potential competitive drug products include:

 

 

Many patients are treated for chronic idiopathic constipation with competing over-the-counter products that are sold for occasional or infrequent use or for recurring use and that are directly competitive with our products.

 

We face similar competition from approved therapies and potential drug products for the diseases and conditions addressed by cobiprostone and SPI-017, and are likely to face significant competition for any other product candidates we may elect to develop in the future.

 

Many of our competitors may have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, conducting clinical trials, obtaining regulatory approvals, and marketing approved products than we do. Smaller or early stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies.

 

The commercial success of Amitiza and any other products that we may develop will depend upon the degree of market acceptance by physicians, patients, healthcare payors and others in the medical community.

 

Amitiza and any other products that we bring to the market may not gain acceptance by physicians, patients, healthcare payors and others in the medical community. If these products do not achieve an adequate level of acceptance, we may not generate sufficient product revenues to become profitable. The degree of market acceptance of Amitiza and any other products approved for commercial sale will depend on a number of factors, including:

 

 

 

The withdrawal of Zelnorm from the U.S. market might adversely affect market acceptance of Amitiza. The FDA requested that Novartis discontinue marketing Zelnorm based on a finding of an increased risk of serious cardiovascular adverse events associated with use of the drug. Although the mechanism of action of Amitiza is different from that of Zelnorm, and although Amitiza has not been associated with serious adverse cardiovascular events, nonetheless the withdrawal of Zelnorm may result in heightened concerns in the minds of some patients or physicians about the safety of using alternative treatments such as Amitiza.

 

In addition, Adolor Corporation, the developer of an opioid antagonist, Entereg^® (alvimopan), for the treatment of opioid-induced bowel dysfunction, recently announced that it was withdrawing its protocol for an additional phase 3 clinical trial of Entereg to treat this condition, which had previously been filed with the FDA. This decision was reportedly based upon preliminary phase 3 trial safety results that suggest potential links between use of Entereg and adverse cardiovascular events, tumor development and bone fractures. It is possible that this development, coming so shortly after the withdrawal of Zelnorm, could further confuse patients and physicians and lead to reluctance on their part to use and to prescribe new drugs to treat gastrointestinal conditions, even those with different mechanisms of action such as Amitiza.

 

If we are unable to obtain adequate reimbursement from third-party payors for Amitiza and any other products that we may develop, or acceptable prices for those products, our revenues and prospects for profitability will suffer.

 

Our revenues and ability to become profitable will depend heavily upon the availability of adequate reimbursement for the use of our products from governmental and other third party payors, both in the United States and in foreign markets. Reimbursement by a third-party payor may depend upon a number of factors, including the third-party payor’s determination that use of a product is:

 

 

Obtaining reimbursement approval for a product from each government or other third-party payor is a time-consuming and costly process that could require us to provide supporting scientific, clinical and cost-effectiveness data for the use of our products to each payor. We may not be able to provide data sufficient to gain acceptance with respect to reimbursement. Even when a payor determines that a product is eligible for reimbursement, the payor may impose coverage limitations that preclude payment for some product uses that are approved by the FDA or comparable authorities. Moreover, eligibility for coverage does not imply that any product will be reimbursed in all cases or at a rate that allows us to make a profit or even cover our costs. If we are not able to obtain coverage and profitable reimbursement promptly from government-funded and private third-party payors for our products, our ability to generate revenues and become profitable will be compromised.

Recent federal legislation will increase the pressure to reduce prices of prescription drugs paid for by Medicare, which could limit our ability to generate revenues.

 

In 2003, the United States government enacted legislation providing a partial prescription drug benefit for Medicare recipients, which became effective at the beginning of 2006. Government payment for some of the costs of prescription drugs may increase demand for any products for which we receive marketing approval. However, to obtain payments under this program, we will be required to sell products to Medicare recipients through drug procurement organizations operating pursuant to this legislation. These organizations will negotiate prices for our products, which are likely to be lower than those we might otherwise obtain. Federal, state and local governments in the United States continue to consider legislation to limit the growth of healthcare costs, including the cost of prescription drugs, in particular through cost-effectiveness evaluations. Future legislation could limit payments for pharmaceuticals such as Amitiza and the other product candidates that we are developing.

 

Legislation has been proposed from time to time that would permit re-importation of drugs from foreign countries into the United States, including foreign countries where the drugs are sold at lower prices than in the United States, which could force us to lower the prices at which we sell our products and impair our ability to derive revenues from these products.

 

Legislation has been introduced from time to time in the U.S. Congress that would permit more widespread re-importation of drugs from foreign countries into the United States. This could include re-importation from foreign countries where the drugs are sold at lower prices than in the United States. Such legislation, or similar regulatory changes, could lead to a decrease in the price we receive for any approved products, which, in turn, could impair our ability to generate revenues. Alternatively, in response to legislation such as this, we might elect not to seek approval for or market our products in foreign jurisdictions in order to minimize the risk of re-importation, which could also reduce the revenue we generate from our product sales.

 

Foreign governments tend to impose strict price controls, which may limit our ability to generate revenues.

 

In some foreign countries, particularly Japan and the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take considerable time after the receipt of marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our products to other available therapies. If reimbursement of our products is unavailable in particular countries or limited in scope or amount, or if pricing is set at unsatisfactory levels, our ability to generate revenue and profitably distribute products in these countries could be compromised.

 

If product liability lawsuits are brought against us, we may incur substantial liabilities and may be required to limit commercialization of any products that we may develop.

 

We face an inherent risk of product liability exposure, both from the testing of our product candidates in human clinical trials and from the sale of Amitiza and any other drugs we may sell in the future. If we cannot successfully defend ourselves against claims that our products or product candidates caused injuries, we will incur substantial liabilities. Regardless of merit or eventual outcome, product liability claims may result in:

 

 

We currently have worldwide product liability insurance that covers our clinical trials and our commercial sales of Amitiza up to an annual aggregate limit of $20.0 million. The amount or scope of our product liability insurance may not be adequate to cover all liabilities that we may incur. Insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost, and we may not be able to obtain insurance coverage that will be adequate to cover any liability that may arise. We may not have sufficient resources to pay for any liabilities resulting from a claim beyond the limits of our insurance coverage. If we cannot protect against product liability claims, we or our collaborators may find it difficult or impossible to commercialize our products.

 

Our strategy of generating growth through acquisitions and in-licenses may not be successful if we are not able to identify suitable acquisition or licensing candidates, to negotiate the terms of any such transaction or to successfully manage the integration of any acquisition.

 

As part of our business strategy, we intend to pursue strategic acquisitions and in-licensing opportunities with third parties to complement our existing product pipeline. We have no experience in completing acquisitions with third parties to date and we may not be able to identify appropriate acquisition or licensing candidates or to successfully negotiate the terms of any such transaction. The licensing and acquisition of pharmaceutical and biological products is a competitive area. A number of more established companies are also pursuing strategies to license or acquire products in the pharmaceutical field, and they may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities. If we are unable to successfully complete acquisitions or in-licensing transactions for suitable products and product candidates, our prospects for growth could suffer.

 

Even if we are successful in completing one or more acquisitions, the failure to adequately address the financial, operational or legal risks of these transactions could harm our business. To finance an acquisition, we could be required to use our cash resources, issue potentially dilutive equity securities or incur or assume debt or contingent liabilities. Accounting for acquisitions can require impairment losses or restructuring charges, large write-offs of in-process research and development expense and ongoing amortization expenses related to other intangible assets. In addition, integrating acquisitions can be difficult, and could disrupt our business and divert management resources. If we are unable to manage the integration of any acquisitions successfully, our ability to develop new products and continue to expand our product pipeline may be impaired.

 

We may need substantial additional funding and be unable to raise capital when needed, which could force us to delay, reduce or abandon our commercialization efforts or product development programs.

 

We expect to incur significant commercialization expenses for product sales, marketing, manufacturing and distribution of Amitiza. In addition, we expect our research and development expenses to increase in connection with our ongoing activities. We may need substantial additional funding and be unable to raise capital when needed or on attractive terms, which would force us to delay, reduce or abandon our commercialization efforts or development programs.

 

We have financed our operations and internal growth principally through private placements and a public offering of equity securities, payments received under our collaboration agreement with Takeda and milestone and other payments from Sucampo AG and R-Tech. We believe that our existing cash and cash equivalents and internally generated funds that we anticipate from Amitiza product sales, will be sufficient to enable us to fund our operating expenses for the foreseeable future. Our future funding requirements, however, will depend on many factors, including:

 

 

 

If we are required to raise additional funds from external sources, we might accomplish this through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements. If we raise additional funds by issuing equity securities, current stockholders may experience dilution. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights and related intellectual property to our technologies, research programs, products or product candidates.

 

Risks Related to Our Dependence on Third Parties, Including Related Parties

 

We have no manufacturing capabilities and are dependent upon R-Tech to manufacture and supply us with our product and product candidates. If R-Tech does not manufacture Amitiza or our other product candidates in sufficient quantities, at acceptable quality levels and at acceptable cost and if we are unable to identify a suitable replacement manufacturer, our sales of Amitiza and our further clinical development and commercialization of other products could be delayed, prevented or impaired.

 

We do not own or operate manufacturing facilities and have little experience in manufacturing pharmaceutical products. We currently rely, and expect to continue to rely, exclusively on R-Tech to supply Takeda and us with Amitiza, cobiprostone and SPI-017 and any future prostone compounds that we may determine to develop or commercialize. We have granted R-Tech the exclusive right to manufacture and supply Amitiza to meet our commercial and clinical requirements throughout the world and we do not have an alternative source of supply for Amitiza. We also do not have an alternative source of supply for cobiprostone or SPI-017, which R-Tech manufactures and supplies to us. If R-Tech is not able to supply Amitiza or these other compounds on a timely basis, in sufficient quantities and at acceptable levels of quality and price and if we are unable to identify a replacement manufacturer to perform these functions on acceptable terms, sales of Amitiza would be significantly impaired and our development programs could be seriously jeopardized.

 

The risks of relying solely on R-Tech for the manufacture of our products include:

 

 

In addition, R-Tech currently uses one supplier for the primary ingredient used in the manufacture of prostones. R-Tech could experience delays in production should it become necessary to switch its source of supply for this ingredient to another supplier or to manufacture the ingredient itself.

 

Our current and anticipated future dependence upon R-Tech for the manufacture of our products and product candidates may adversely affect our future revenues, our cost structure and our ability to develop product candidates and commercialize any approved products on a timely and competitive basis. In addition, if R-Tech should cease to manufacture prostones for our clinical trials for any reason, we likely would experience delays in advancing these trials while we seek to identify and qualify replacement suppliers. We may be unable to obtain replacement supplies on a timely basis, on terms that are favorable to us or at all.

 

We and R-Tech are dependent upon a single contract manufacturer to complete the final stage of manufacture of Amitiza.

 

R-Tech has subcontracted with a single contract manufacturer to encapsulate the bulk form Amitiza supplied by R-Tech into gelatin capsules and to package the final product for distribution in the United States. If this subcontractor experiences difficulties or delays in performing these services for any reason, our ability to deliver adequate supplies of finished product to physicians and patients will be impaired during the period in which R-Tech seeks a replacement manufacturer, which could cause us to lose revenues. In addition, any change in the party providing encapsulation of Amitiza would need to be approved by the FDA, and any change in the party packaging the product would need to be submitted to and reviewed by the FDA, which could increase the time required to replace this subcontractor should that become necessary.

 

R-Tech and any other third-party manufacturer of our products and product candidates are subject to significant regulations governing manufacturing facilities and procedures.

 

R-Tech, R-Tech’s subcontractors and suppliers and any other potential manufacturer of our products or product candidates may not be able to comply with the FDA’s cGMP regulations, other U.S. regulations or similar regulatory requirements in force outside the United States. These regulations govern manufacturing processes and procedures and the implementation and operation of systems to control and assure the quality of products approved for sale. In addition, the FDA or other regulatory agencies outside the United States may at any time audit or inspect a manufacturing facility to ensure compliance with cGMP or similar regulations. Our failure, or the failure of R-Tech, R-Tech’s subcontractors and suppliers or any other third-party manufacturer we use, to comply with applicable manufacturing regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of our product candidates, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of product candidates or products, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect supplies of our products and product candidates.

 

If it were to become necessary for us to replace R-Tech as contract manufacturer of our product and product candidates, we would compete with other products for access to appropriate manufacturing facilities and the change would need to be submitted to and approved by the FDA. Among manufacturers that operate under cGMP regulations, there are a limited number that would be both capable of manufacturing for us and willing to do so.

 

We depend significantly on our collaborations with Takeda and Abbott, and may depend in the future on collaborations with other third parties, to develop and commercialize our product candidates.

 

A key element of our business strategy is to collaborate where appropriate with third parties, particularly leading pharmaceutical companies, to develop, commercialize and market our products and product candidates. We are currently party to a 16-year joint collaboration and license agreement with Takeda for the development and commercialization of Amitiza for gastrointestinal indications in the United States and Canada. We are also party to an agreement with Abbott for the development and commercialization of lubiprostone in Japan.

The success of our collaboration arrangement will depend heavily on the efforts and activities of Takeda and Abbott. The risks that we face in connection with this collaboration and that we anticipate being subject to in any future collaborations, include the following:

 

 

The ability of our products and product candidates to reach their potential could be limited if Takeda, Abbott or any other future collaborators decrease or fail to increase spending relating to such products, fail to dedicate sufficient resources to developing or promoting our products or change their business focus.

 

Because we rely upon third parties to provide the sales representatives marketing Amitiza, we may face increased risks arising from their misconduct or improper activities, which would harm our business.

 

Because we will have only limited capacity to monitor the sales efforts of Takeda’s sales force, we may be exposed to increased risks arising from any misconduct or improper activities of these sales representatives, including the potential off-label promotion of our products or their failure to adhere to standard requirements in connection with product promotion. In addition, we will be exposed to similar risks arising from our previous use of a third-party contractor’s employees to market Amitiza. Although we amended our agreement with the contractor and ceased to use its employees effective July 1, 2007, any misconduct or inappropriate activities by those employees prior to termination could create future liabilities for us, and any misconduct or inappropriate activities might not come to light for an extended period after the termination. Any such improper activities could hurt our reputation, cause us to become subject to significant liabilities and otherwise harm our business.

 

We may not be successful in establishing additional collaborations, which could compromise our ability to develop and commercialize products.

 

If we are unable to reach new agreements with suitable collaborators, we may fail to meet our business objectives for the affected product or program. We face significant competition in seeking appropriate collaborators. Moreover, these collaboration arrangements are complex and time-consuming to negotiate and document. We may not be successful in our efforts to establish additional collaborations or other alternative arrangements. The terms of any additional collaborations or other arrangements that we establish may not be as favorable to us as we anticipate. Moreover, these collaborations or other arrangements may not be successful.

 

We rely on third parties to conduct our clinical trials and those third parties may not perform satisfactorily or may fail to meet established deadlines for the completion of these trials.

 

We generally do not have the independent ability to conduct clinical trials for our product candidates. We rely on third parties, such as contract research organizations, clinical data management organizations, medical institutions, and clinical investigators, to perform this function. For example, approximately 130 separate clinical

investigators participated in our trials for irritable bowel syndrome with constipation. We use multiple contract research organizations to coordinate the efforts of our clinical investigators and to accumulate the results of our trials. Our reliance on these third parties for clinical development activities reduces our control over these activities. Furthermore, these third parties may also have relationships with other entities, some of which may be our competitors. If these third parties do not carry out their contractual duties or meet expected deadlines, we will be delayed in obtaining, or may not be able to obtain, regulatory approvals for our product candidates and will be delayed in our efforts to, or may not be able to, successfully commercialize our product candidates.

 

In addition, we are responsible for ensuring that each of our clinical trials is conducted in accordance with the general investigational plan and protocols for the trial. The FDA requires us to comply with standards, commonly referred to as good clinical practices, for conducting and recording and reporting the results of clinical trials to assure that data and reported results are credible and accurate and that the rights, integrity and confidentiality of trial participants are protected. Our reliance on third parties that we do not control does not relieve us of these responsibilities and requirements.

 

Conflicts of interest may arise between Sucampo AG or R-Tech and us, and these conflicts might ultimately be resolved in a manner unfavorable to us.

 

Our founders, Dr. Sachiko Kuno and Dr. Ryuji Ueno, together wholly own Sucampo AG and own a majority of the stock of R-Tech. Drs. Kuno and Ueno are married to each other. Ownership interests of our founders in the stock of R-Tech or Sucampo AG, and Dr. Ueno’s service as a director and executive officer of our Company and Dr. Kuno’s service as a director of our Company, could give rise to conflicts of interest when faced with a decision that could favor the interests of one of the affiliated companies over another. In addition, conflicts of interest may arise with respect to existing or possible future commercial arrangements between us and R-Tech or Sucampo AG in which the terms and conditions of the arrangements are subject to negotiation or dispute. For example, conflicts of interest could arise over matters such as:

 

 

If tax authorities disagree with our transfer pricing policies or other tax positions, we could become subject to significant tax liabilities.

 

We are a member of an affiliated group of entities, including Sucampo AG and R-Tech, each of which is directly or indirectly controlled by Drs. Ueno and Kuno. We have had and will continue to have significant commercial transactions with these entities. Furthermore, we operate two foreign subsidiaries, Sucampo Japan and Sucampo Europe. We expect to enter into commercial transactions with each of these entities on an ongoing basis. As a result of these transactions, we will be subject to complex transfer pricing regulations in both the United States and the other countries in which we and our affiliates operate. Transfer pricing regulations generally require that, for tax purposes, transactions between our subsidiaries and affiliates and us be priced on a basis that would be comparable to an arm’s length transaction and that contemporaneous documentation be maintained to support the related party agreements. To the extent that United States or any foreign tax authorities disagree with our transfer pricing policies, we could become subject to significant tax liabilities and penalties related to prior, existing and future related party agreements. As of December 31, 2008, we performed updated tax analyses wherein liabilities for uncertain tax positions were recorded for certain state jurisdictions based on nexus related to the sourcing of

revenues. Should the tax authorities in one or more of these states have different interpretations than us, we may be subject to additional tax liabilities.

 

Risks Related to Our Intellectual Property

 

If we are unable to obtain and maintain proprietary protection for the intellectual property relating to our technology and products, the value of our technology and products will be adversely affected and our ability to derive revenue from our products would be impaired.

 

Our success depends in part on our ability, and that of Sucampo AG, to obtain and maintain proprietary protection for the technology and know-how upon which our products are based, to operate without infringing on the proprietary rights of others and to prevent others from infringing on our proprietary rights. The patent positions of companies like ours are generally uncertain and involve complex legal and factual questions. Our ability to maintain and solidify our proprietary position for our intellectual property will depend on our success, in conjunction with Sucampo AG, in obtaining effective claims and enforcing those claims once granted. The scope of protection afforded by a set of patent claims is subject to inherent uncertainty unless the patent has already been litigated and a court has ruled on the meaning of the claim language and other issues affecting how broadly a patent claim can be enforced. In some cases, we license patent applications from Sucampo AG instead of issued patents, and we do not know whether these patent applications will result in the issuance of any patents. Our licensed patents may be challenged, invalidated or circumvented, which could limit the term of patent protection for our products or diminish our ability to stop competitors from marketing related products. In addition, changes in either patent laws or in interpretations of patent laws in the United States and other countries may diminish the value of Sucampo AG’s patents and our intellectual property or narrow the scope of the protection provided by these patents. Accordingly, we cannot determine the degree of future protection for our proprietary rights in the licensed patents and patent applications. Furthermore, because of the extensive time required for development, testing and regulatory review of a potential product, it is possible that, before any of our product candidates can be commercialized, a related patent may expire or may remain in force for only a short period following commercialization, thereby reducing any advantage of the patent.

 

The patents we license from Sucampo AG also may not afford us protection against competitors with similar technology. Because patent applications in the United States and many foreign jurisdictions are typically not published until 18 months after filing, or in some cases not at all, and because publications of discoveries in the scientific literature often lag behind actual discoveries, neither we nor Sucampo AG can be certain that we or they were the first to make the inventions claimed in issued patents or pending patent applications, or that we or they were the first to file for protection of the inventions set forth in these patent applications.

 

Confidentiality agreements with our employees and other precautions may not be adequate to prevent disclosure of our proprietary information and know-how.

 

In addition to patented technology, we rely upon unpatented proprietary technology, processes and know-how developed both by Sucampo AG and by us. We and Sucampo AG seek to protect our respective proprietary technology and processes, in part, by confidentiality agreements with our respective employees, consultants, scientific advisors and contractors. We also seek to preserve the integrity and confidentiality of our data and trade secrets by maintaining physical security of our premises and physical and electronic security of our information technology systems. These agreements or security measures may be breached, and we and Sucampo AG may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors. If we or Sucampo AG are unable to protect the confidentiality of our proprietary information and know-how, competitors may be able to use this information to develop products that compete with our products, which could compromise our ability to produce revenue and achieve profitability.

 

If we infringe or are alleged to infringe intellectual property rights of third parties, our business could be harmed.

 

There has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the pharmaceutical and biotechnology industries. Our research, development and commercialization

activities and those of Sucampo AG, as well as any products or product candidates resulting from these activities, may infringe or be alleged to infringe patents or patent applications owned or controlled by other parties. These third parties could bring claims against us or one of our collaborators that would require us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages. Further, if a patent infringement suit were brought against us or one of our collaborators, we or they could be forced to stop or delay research, development, manufacturing or sales of the product or product candidate that is the subject of the suit.

 

As a result of patent infringement claims, or in order to avoid potential claims, we or one of our collaborators may choose or be required to seek a license from a third party and be required to pay license fees or royalties or both. These licenses may not be available on acceptable terms, or at all. Even if we or a collaborator were able to obtain a license, the rights may be nonexclusive, which could result in our competitors gaining access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations, if, as a result of actual or threatened patent infringement claims, we or one of our collaborators are unable to enter into licenses on acceptable terms. This could harm our business significantly.

 

We may be subject to other patent related litigation or proceedings that could be costly to defend and uncertain in their outcome.

 

In addition to infringement claims against us, we may become a party to other patent litigation and proceedings, including interference proceedings declared by the United States Patent and Trademark Office or opposition proceedings in the European Patent Office regarding intellectual property rights with respect to our products and technology, as well as other disputes with licensees, licensors or others with whom we have contractual or other business relationships for intellectual property. The cost to us of any patent litigation or other proceeding, even if resolved in our favor, could be substantial. Some of our competitors may be able to sustain the costs of such litigation or proceedings more effectively than we can because of their substantially greater financial resources. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could negatively affect our ability to compete in the marketplace. Patent litigation and other proceedings may also absorb significant management resources.

 

Risks Related to Regulatory Approval and Oversight

 

If we are not able to obtain required regulatory approvals, we will not be able to commercialize our product candidates and our ability to generate revenue will be materially impaired.

 

Our product candidates and the activities associated with their development and commercialization, including testing, manufacture, safety, efficacy, recordkeeping, labeling, storage, approval, advertising, promotion, sale and distribution, are subject to comprehensive regulation by the FDA and other regulatory agencies in the United States and by authorities in other countries. Failure to obtain regulatory approval for a product candidate will prevent us from commercializing the product candidate.

 

Securing FDA approval requires the submission of extensive preclinical and clinical data, information about product manufacturing processes and inspection of facilities and supporting information to the FDA for each therapeutic indication to establish the product candidate’s safety and efficacy. Our future products may not be effective, may be only moderately effective or may prove to have undesirable side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use.

 

The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon the type, complexity and novelty of the product candidates involved. Changes in the regulatory approval policy during the development period, changes in or the enactment of additional statutes or regulations, or changes in regulatory review for each submitted product application, may cause delays in the approval or rejection of an application. The FDA has substantial discretion in the approval process and may refuse to accept any application or may decide that our data are insufficient for approval and require additional preclinical, clinical or other studies. In addition, varying interpretations of the data obtained from preclinical and clinical testing could delay, limit or prevent regulatory approval of a product candidate. Any regulatory approval we ultimately obtain may be limited in scope or subject to restrictions or post-approval commitments that render the

product not commercially viable. If any regulatory approval that we obtain is delayed or is limited, we may decide not to commercialize the product candidate after receiving the approval.

 

Even if we receive regulatory approval for a product, the product could be subject to regulatory restrictions or withdrawal from the market, and we may be subject to penalties if we fail to comply with ongoing regulatory requirements.

 

Amitiza and any other product for which we obtain marketing approval, along with the manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for such product, will be subject to continual requirements of and review by the FDA and other regulatory bodies. These requirements include submissions of safety and other post-marketing information and reports, registration requirements, cGMP requirements relating to quality control, quality assurance and corresponding maintenance of records and documents, requirements regarding the distribution of samples to physicians and recordkeeping. Even if regulatory approval of a product is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or to the conditions of approval, or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product. If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.

 

We may experience unanticipated safety issues with our products after they are approved for marketing, which could harm our business and our reputation.

 

Because Amitiza and our other product candidates are based on newly discovered prostone technology with novel mechanisms of action, there may be long-term safety risks associated with these products that are not identifiable or well-understood at early stages of development and commercialization. Later discovery of previously unknown problems with our products, manufacturers or manufacturing processes may result in:

 

 

Because we rely on Takeda to provide a significant portion of the sales force that is selling Amitiza, we are dependent to some degree on Takeda to promptly and properly report any safety issues encountered in the field. If Takeda or their sales representatives fail to provide timely and accurate reporting of any safety issues that arise in connection with Amitiza, our business and reputation could be harmed.

 

Failure to obtain regulatory approval in international jurisdictions would prevent us from marketing our products outside the United States and could adversely affect our reputation and our product marketing activities within the United States.

 

We intend to market our products both domestically and outside the United States. In order to market our products in the European Union, Japan and many other foreign jurisdictions, we must obtain separate regulatory approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and can involve additional testing. The time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval. We may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries or jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or jurisdictions or by the FDA. We may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market.

We may not be able to obtain orphan drug exclusivity for our product candidates. If our competitors are able to obtain orphan drug exclusivity for a product that is competitive with one or more of our product candidates and we cannot show that our product candidate is clinically superior, we may not be able to have competing products approved by the applicable regulatory authority for a significant period of time.

 

Regulatory authorities in some jurisdictions, including Europe and the United States, may designate drugs that target relatively small patient populations as orphan drugs. We have received an orphan drug designation from the FDA for our product candidate cobiprostone for the treatment of disorders associated with cystic fibrosis and we may pursue orphan drug designation for additional product candidates. Generally, if a product with an orphan drug designation subsequently receives the first marketing approval for the indication for which it has such designation, the product is entitled to a period of marketing exclusivity. The exclusivity applies only to the indication for which the drug has been designated and approved. The applicable exclusivity period is seven years in the United States, but this period may be interrupted if a sponsor of a competitive product that is otherwise the same drug for the same use can show that its drug is clinically superior to our orphan drug candidate. The European exclusivity period is ten years, but may be reduced to six years if a drug no longer meets the criteria for orphan drug designation, including where it is shown that the drug is sufficiently profitable so that market exclusivity is no longer justified. In addition, European regulations establish that a competitor’s marketing authorization for a similar product with the same indication may be granted if there is an insufficient supply of the product or if another applicant can establish that its product is safer, more effective or otherwise clinically superior. If a competitor obtains orphan drug exclusivity for a product competitive with cobiprostone before we do and if the competitor’s product is the same drug with the same indication as ours, we would be excluded from the market, unless we can show that our drug is safer, more effective or otherwise clinically superior. Even if we obtain orphan drug exclusivity for cobiprostone for these indications, we may not be able to maintain it if a competitor with a product that is otherwise the same drug can establish that its product is clinically superior.

 

We must comply with federal, state and foreign laws, regulations, and other rules relating to the health care business, and, if we are unable to fully comply with such laws, regulations and other rules, we could face substantial penalties.

 

We are or will be directly or indirectly through our customers, subject to extensive regulation by the federal government, the states and foreign countries in which we may conduct our business. The laws that directly or indirectly affect our ability to operate our business include the following:

 

 

If our operations are found to be in violation of any of the laws, regulations, rules or policies described above or any other law or governmental regulation to which we or our customers are or will be subject, or if the interpretation of the foregoing changes, we may be subject to civil and criminal penalties, damages, fines, exclusion from the

Medicare and Medicaid programs and the curtailment or restructuring of our operations. Similarly, if our customers are found non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us. Any penalties, damages, fines, curtailment or restructuring of our operations would harm our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions may be open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert management resources from the operation of our business and damage our reputation.

 

Risks Related to Our Common Stock

 

Our founders, who are also members of our board of directors, maintain the ability to control all matters submitted to stockholders for approval, which could result in actions of which you or other stockholders do not approve.

 

Our founders, Dr. Sachiko Kuno, one of our directors, and Dr. Ryuji Ueno, our chief executive officer, chief scientific officer and a director, together beneficially own 1,893,885 shares of class A common stock and 26,191,050 shares of class B common stock, representing approximately 95% of the combined voting power of our outstanding common stock. As a result, Drs. Ueno and Kuno, who are married, acting by themselves, are able to control the outcome of all matters that our stockholders vote upon, including the election of directors, amendments to our certificate of incorporation, and mergers or other business combinations. The concentration of ownership and voting power also may have the effect of delaying or preventing a change in control of our company and could prevent stockholders from receiving a premium over the market price if a change in control is proposed.

 

Provisions in our corporate charter documents and under Delaware law may prevent or frustrate attempts by our stockholders to change our management and hinder efforts to acquire a controlling interest in us, and the market price of our class A common stock may be lower as a result.

 

There are provisions in our certificate of incorporation and by-laws that may make it difficult for a third party to acquire, or attempt to acquire, control of our company, even if a change in control was considered favorable by you and other stockholders. For example, our board of directors has the authority to issue up to 5,000,000 shares of preferred stock. The board of directors can fix the price, rights, preferences, privileges, and restrictions of the preferred stock without any further vote or action by our stockholders. The issuance of shares of preferred stock may delay or prevent a change in control transaction. As a result, the market price of our class A common stock and the voting and other rights of our stockholders may be adversely affected. An issuance of shares of preferred stock may result in the loss of voting control to other stockholders.

 

Our charter documents contain other provisions that could have an anti-takeover effect, including:

 

 

In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. These provisions could discourage potential acquisition proposals and

could delay or prevent a change in control transaction. They could also have the effect of discouraging others from making tender offers for our class A common stock. These provisions may also prevent changes in our management.

 

Our class A common stock is thinly traded and our stock price is volatile; investors in our class A common stock could incur substantial losses.

 

The public trading market for our class A common stock is characterized by small trading volumes and a highly volatile stock price. The stock market in general and the market for pharmaceutical and biotechnology companies in particular have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. As a result of this volatility, investors may not be able to sell their class A common stock at or above the price they paid, and may have difficulty selling their shares at any price. The market price for our class A common stock may be influenced by many factors, including:

 

 

We have never paid cash dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.

 

We have paid no cash dividends on our capital stock to date. We currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, the terms of any existing or future debt agreements may preclude us from paying dividends. As a result, capital appreciation, if any, of our class A common stock will be your sole source of gain for the foreseeable future.

 

A significant portion of our total outstanding shares are eligible to be sold into the market. This could cause the market price of our class A common stock to drop significantly, even if our business is doing well.

 

Sales of a substantial number of shares of our class A common stock in the public market could occur at any time. If our stockholders sell, or the market perceives that our stockholders intend to sell, substantial amounts of our class A common stock in the public market, the market price of our class A common stock could decline significantly. Virtually all of our outstanding shares of common stock are eligible to be resold in the public markets, including approximately 37.5 million shares that first became available for sale in the public market in February 2008 following the expiration of lock-up agreements between our stockholders and the underwriters of our public offering, subject in some cases to volume limitations imposed by federal securities laws. Moreover, holders of an aggregate of approximately 6,751,609 shares of our common stock have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. We also registered the 13,900,900 shares of class A common stock

that we may issue in the future under our equity compensation plans, and they can be freely sold in the public market upon issuance.

 

Due to recent uncertainties in the credit markets, we may be unable to liquidate some holdings of our auction rate securities and as a result, may suffer losses from these investments. In addition, given the complexity of auction rate securities and their valuations, our estimates of their fair value may differ from the actual amount we would be able to collect in an ultimate sale.

 

As of December 31, 2008, we had $19.4 million invested in auction rate securities, or ARS. ARS are long-term debt instruments that provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined calendar intervals, generally every seven to 49 days. This mechanism generally allows existing investors to roll-over their holdings and continue to own their respective securities or liquidate their holdings by selling their securities at par value.

 

Historically, we invested in ARS for short periods of time as part of our cash management program. Recent uncertainties in the credit markets have prevented us from liquidating some of our holdings of ARS during the year because the amount of securities submitted for sale during the auction exceeded the amount of purchase orders.

 

On October 16, 2008, we accepted a settlement rights offer from the broker UBS, AG of Auction Rate Security Rights. This offer permits us to require UBS to purchase our ARS at par value between June 30, 2010 and July 2, 2012. In exchange, we granted UBS the right, at their sole discretion, to sell or otherwise dispose of our ARS at any time during the same period.

 

It is uncertain as to when the liquidity issues relating to these investments will improve. Although we do not currently anticipate having to sell these securities in order to operate our business, if that were to change, or if such liquidity issues continue over a prolonged period, we might be unable to liquidate some holdings of our ARS and, as a result, might suffer losses from these investments. In addition, given the complexity of ARS and their valuations, our estimates of their fair value may differ from the actual amount we would be able to collect in an ultimate sale. Although our arrangement with UBS provides some comfort that we will eventually be able to liquidate our ARS holdings, we cannot provide any assurance that UBS will be in a position to honor its commitment to repurchase our ARS during the specified period.

 

 

None.

 

 

Our corporate headquarters, including our principal executive office, and some of our commercial, administrative and research and development activities, are located in Bethesda, Maryland. Our lease for this facility, which comprises approximately 25,000 square feet of office space, expires in February 2017. In addition, we have a short-term lease in Fuquay-Varina, North Carolina to house our national sales office.

 

In July 2007, we vacated our previous headquarters in Bethesda, Maryland. We sublet 1,600 square feet of space under a lease that expires in December 2010 and sublet 11,166 square feet of space under a lease that expires in November 2009. We remain obligated to make rent payments under both leases.

 

We lease our Asian and European headquarters, located in Tokyo and Osaka, Japan and Oxford, England, under short-term leases, which comprises an aggregate of approximately 3,626 square feet of space.

 

We believe that our current facilities are sufficient to meet our needs for at least the next 12 months.

 

 

We are not currently a party to any legal proceedings of which the ultimate outcome, in our judgment, would have a material adverse effect on our business, financial condition or results of operations.

 

No matters were submitted to a vote of security holders during the quarter ended December 31, 2008.

 

 

Our class A common stock is traded on The NASDAQ Global Market under the symbol “SCMP”. The following table sets forth, for the periods indicated, the range of high and low sale prices of our class A common stock as reported on The NASDAQ Global Market since our initial public offering on August 2, 2007.

 

 

As of March 5, 2009, we had 15,651,849 shares of class A common stock outstanding held by 13 stockholders of record. The number of holders of record of our class A common stock is not representative of the number of beneficial holders because many shares are held by depositories, brokers or nominees. As of March 5, 2009, the closing price of our class A common stock was $3.88. As of March 5, 2009, we had 26,191,050 shares of class B common stock outstanding held by one stockholder of record.

 

We have never declared or paid any cash dividends on our common stock. We currently intend to retain earnings, if any, to support our growth strategy and do not anticipate paying cash dividends in the foreseeable future.

 

On December 9, 2008 our board of directors authorized and approved a stock repurchase program, under which we may use up to $10 million to purchase shares of our class A common stock from time to time in open-market transactions, depending on market conditions and other factors. We did not repurchase any of our equity securities in 2008.

 

The equity compensation plan information required under this Item is incorporated by reference to the information provided under the heading “Equity Compensation Plan Information” in our proxy statement to be filed within 120 days after the fiscal year end of December 31, 2008.

Stock Performance Graph

 

The information included under this heading “Stock Performance Graph” is “furnished” and not “filed” and shall not be deemed to be “soliciting material” or subject to Regulation 14A, shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act.

 

The following graph compares the cumulative total return, assuming the investment of $100 on August 2, 2007, the date on which our class A common stock began trading on The NASDAQ Global Market, in each of (1) our class A common stock, (2) The NASDAQ Composite Index (U.S. and Foreign) and (3) the NASDAQ Pharmaceutical Index, assuming reinvestment of any dividends. These comparisons are required by the SEC and are not intended to forecast or be indicative of possible future performance of our class A common stock.

 

 

We have derived the following consolidated financial data as of December 31, 2005, 2006, 2007 and 2008 and for the years then ended from our audited consolidated financial statements. Consolidated balance sheets as of December 31, 2007 and 2008 and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity and cash flows for each of the three years ended December 31, 2006, 2007 and 2008 and notes thereto appear elsewhere in this Annual Report. We have derived the following consolidated financial data as of December 31, 2004 from our unaudited consolidated balance sheet and consolidated financial data as of December 31, 2005 and for the two years then ended, from audited consolidated financial statements, which are not included in this Annual Report. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related footnotes appearing elsewhere in this Annual Report on Form 10-K.

 

 

 

 

You should read the following discussion and analysis together with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that are based on our current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under Item 1A — “Risk Factors” and elsewhere in this Annual Report.

 

Overview

 

We generate revenue mainly from product development milestone payments, product royalties, and research and development activities. Although we reported net income for the years ended December 31, 2008, 2007 and 2006, we have incurred operating losses in the past, resulting principally from costs incurred in our research and development programs and from our general and administrative expenses. We expect to continue to incur significant expenses for the next several years as we continue to expand our research and development activities, seek regulatory approvals for additional indications for Amitiza and for other compounds in the United States and abroad and expand our international operations. While we expect future profitability, whether we are able to sustain profitability will depend upon our ability to generate sufficient revenues and receive payments under our contracts with Takeda, Abbott and similar future arrangements. In the near term, our ability to generate product revenues will depend primarily on the growth in our product commercialization, continued development of additional indications for Amitiza and success in new clinical developments currently in progress.

 

In August 2007, we completed our initial public offering, consisting of 3,125,000 shares of class A common stock sold by us, 625,000 shares of class A common stock sold by a stockholder and 562,500 shares of class A common stock sold under an overallotment option by S&R, at a public offering price of $11.50 per share, resulting in gross proceeds to us of approximately $35.9 million. After deducting underwriters’ discounts and commissions and expenses of the offering, including costs of $3.1 million incurred in 2006, we raised net proceeds of $28.2 million.

 

Financial Terms of our Collaboration with Takeda

 

We entered into a 16-year collaboration agreement with Takeda in October 2004 to jointly develop and commercialize Amitiza for gastrointestinal indications in the United States and Canada. We also entered into a related supplemental agreement with Takeda in February 2006. Under the terms of these agreements, we have received a variety of payments and will have the opportunity to receive additional payments in the future.

Up-front Payment

 

Upon signing the original collaboration agreement with Takeda, we received a non-refundable up-front payment of $20.0 million. We deferred $2.4 million of this up-front payment associated with our obligation to participate in joint committees with Takeda and we are recognizing this amount as collaboration revenue ratably over the 16-year life of the agreement. We recognized the remaining $17.6 million as research and development revenue ratably over the estimated development period associated with the chronic idiopathic constipation and irritable bowel syndrome with constipation indications, which was completed in June 2007 as evidenced by the filing with the FDA of a supplement to our existing NDA for Amitiza relating to the treatment of irritable bowel syndrome with constipation.

 

Product Development Milestone Payments

 

We have received the following non-refundable payments from Takeda reflecting our achievement of specific product development milestones, which we recognized either ratably over the estimated development period associated with the chronic idiopathic constipation and irritable bowel syndrome with constipation indications, which was completed in June 2007 or upon completion of performance obligations in case where milestone payments were received after the associated development period.

 

 

Subject to our achieving further product development milestones, we are potentially entitled to receive up to $10.0 million in additional payments from Takeda.

 

Research and Development Cost-Sharing for Amitiza

 

Our collaboration agreement and related supplemental agreement with Takeda provides for the sharing with Takeda the costs of our research and development activities for Amitiza in the United States and Canada as follows:

 

Research and development expense related to Amitiza for the treatment of chronic idiopathic constipation and irritable bowel syndrome with constipation:

 

 

 

Research and development expense related to Amitiza for the treatment of gastrointestinal indications other than chronic idiopathic constipation and irritable bowel syndrome with constipation:

 

 

Co-Promotion Expense Reimbursements

 

In connection with our exercise of our co-promotion rights under the collaboration agreement and our entry into a related supplemental agreement in February 2006, Takeda agreed to reimburse us for a portion of our expenses related to our specialty sales force. We recognized $4.8 million, $4.3 million and $3.4 million of co-promotion revenue reflecting these reimbursements for the years ended December 31, 2008, 2007 and 2006 respectively.

 

Takeda also agreed to reimburse us for all of the costs we incur in connection with specified miscellaneous marketing activities related to the promotion of Amitiza. During the years ended December 31, 2007 and 2006, we recognized $158,000 and $779,000, respectively, as co-promotion revenue reflecting these reimbursements. We completed the miscellaneous marketing activities, to which these reimbursements relate, during the year ended December 31, 2007 and, accordingly, we did not recognize any co-promotion revenue towards miscellaneous marketing activities in 2008 and we do not expect to recognize additional co-promotion revenue related to these activities in the future.

 

Product Royalty Revenue

 

Takeda is obligated to pay us a varying royalty based on a percentage of the net sales revenue from the sale of Amitiza in the United States and Canada. The actual percentage depends on the level of net sales revenue attained each calendar year. All sales of Amitiza in the United States and Canada, including those arranged by our specialty

sales force, will be made through Takeda. During the years ended December 31, 2008, 2007 and 2006, we recognized a total of $34.4 million, $27.5 million and $6.6 million, respectively, as product royalty revenue.

 

Commercialization Milestone Payments

 

Our collaboration agreement also requires Takeda to pay us up to an additional aggregate of $50.0 million conditioned upon the achievement of specified targets for annual net sales revenue from Amitiza in the United States and Canada. We had not met these targets as of December 31, 2008.

 

Takeda Cash Flows and Revenue

 

The following table summarizes the cash streams and related collaboration and research and development revenue recognized under the Takeda Agreements:

 

 

 

 

Financial Terms of our License from Sucampo AG

 

We paid Sucampo AG the following milestone royalty payments that were expensed as incurred and recorded as milestone royalties — related parties in the respective periods.

 

 

Additionally, we expensed $6.0 million, $4.9 million and $1.2 million in product royalties to Sucampo AG during the years ended December 31, 2008, 2007 and 2006 respectively, reflecting 3.2% of Amitiza net sales during each of these years, which we recorded as product royalties — related parties on the consolidated statements of operations and comprehensive income.

Supply Agreement with R-Tech

 

We entered into an exclusive supply arrangement with our affiliate, R-Tech, in March 2003. In return for the exclusive right to manufacture and supply clinical and commercial supplies of Amitiza and a second prostone compound that we are no longer developing in North, Central and South America, including the Caribbean, R-Tech agreed to make the following milestone payments to us:

 

 

We evaluated the $6.0 million in cash receipts from R-Tech and determined these payments were made for the exclusive right to supply inventory to us and, accordingly, should be deferred until commercialization of the drugs begins. We also were unable to accurately apportion value between Amitiza and the other compound based on the information available to us and determined that the full $6.0 million deferred amount should be amortized over the contractual life of the relationship, which we concluded was equivalent to the commercialization period of Amitiza and the other compound. Accordingly, we began recognizing this revenue during the year ended December 31, 2006 and will continue recognizing it ratably on a straight-line basis over the remaining life of our supply agreement with R-Tech through 2026. We recognized $418,000 for the years ended December 31, 2008 and 2007 and $404,000 for the year ended December 31, 2006 as contract revenue — related parties under this exclusive supply arrangement with R-Tech.

 

In June 2005, Sucampo Europe entered into an exclusive supply agreement with R-Tech. In return for the exclusive right to manufacture and supply clinical and commercial supplies of Amitiza in Europe, the Middle East and Africa. R-Tech agreed to pay us $2.0 million in anticipation of entering into this agreement, which we received in March 2005. We determined that this payment should be deferred until commercialization of Amitiza begins within the specified territories in Europe, the Middle East and Africa and, accordingly, the entire $2.0 million is reflected as deferred revenue at December 31, 2008.

 

Critical Accounting Policies and Estimates

 

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses. Actual results may differ significantly from those estimates under different assumptions and conditions.

 

We regard an accounting estimate or assumption underlying our financial statements as a critical accounting estimates if:

 

 

Our significant accounting policies are described in more detail in Note 2 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

 

Current and Non-Current Investments

 

Current and non-current investments consist primarily of U.S. Treasury bills, notes and auction rate securities. We account for these investments under the guidance of Statement of Financial Accounting Standards, or SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. We classify these investments

into current and non-current based on their maturities and our reasonable expectation to recognize these investments in cash. Interest and dividend income is recorded when earned and included in interest income. During the years ended December 31, 2008, 2007 and 2006, there were no current or non-current investments that were purchased at a premium or discount. We use the specific identification method in computing realized gains and losses on sale of our securities. There were no gains or losses realized on the sale of these investments during 2008, 2007 and 2006.

 

Auction rate securities

 

As of December 31, 2008, all of our auction rate securities, or ARS, consisted of AAA or A rated non-mortgage related ARS. Although the ARS have variable interest rates which typically reset every seven to 49 days through a competitive bidding process known as a “Dutch auction,” they have long-term contractual maturities usually exceeding ten years, and therefore are not classified as cash equivalents. As a result of recent liquidity issues in the global credit and capital markets, it has been difficult to sell these securities in the open market.

 

On October 16, 2008, we accepted a settlement rights offer from the broker UBS, AG of Auction Rate Security Rights. This offer permits us to require UBS to purchase our ARS at par value between June 30, 2010 and July 2, 2012. In exchange, we granted UBS the right, at their sole discretion, to sell or otherwise dispose of our ARS at any time during the same period. As of December 31, 2008, we have recorded an asset of $2.8 million for the fair value of settlement rights offered by UBS for redemption of our outstanding ARS at par value.

 

The unique circumstances associated with the auction rate securities markets and the settlement rights has resulted in the reclassification of our investment in auction rate securities from available-for-sale securities to trading securities, which requires us to record an unrealized gain or loss in the consolidated statement of operations and comprehensive income. Accordingly, we recognized $3.2 million of unrealized losses on auction rate securities for the year ended December 31, 2008. We will continue to record fair value changes for the trading securities as a gain or loss in the statement of operations and comprehensive income.

 

Other current and non-current investments

 

Our other investments consist primarily of money market instruments such as U.S. Treasury bills and treasury funds. These investments are classified as available-for-sale securities.

 

Fair Value Estimates

 

We adopted the provisions of Statement of Financial Accounting Standards or SFAS No. 157 Fair Value Measurements, effective January 1, 2008 for our financial assets and liabilities. Our financial assets and liabilities subject to the disclosure requirements of SFAS 157 include investments-current and non-current and ARS related settlement rights asset. We determined the fair market value of other financial assets and liabilities to be the carrying values as of yearend.

 

Fair value estimate for auction rate securities

 

ARS have historically been long-term notes that acted like short-term debt, because their coupon rates reset in regular and frequent Dutch auctions, typically every seven to 49 days. The recent uncertainties in the credit markets have disrupted the liquidity of this process resulting in failed auctions. The breakdown in the auction process affects our estimate of term to maturity in valuing these investments.

 

The current lack of marketability prevented us from comparing our ARS directly to securities with quoted market prices or finding secondary market indications of the prices at which investors are willing to buy and sell auction rate securities. Therefore, we used the income approach model as the primary quantitative valuation technique for valuing the ARS during the year ended December 31, 2008. We used the income approach consistently during the year and there are no changes in the valuation technique.

 

In developing the valuation model, we determined expected cash flows, expected period coupon rate, market rate of return or margin and the expected term of investments as key inputs. The value of the ARS was then determined as equal to the value of the principal plus return on investment discounted at the required market rate of return over the life of our investment. In simulating the estimated coupon rate and other variables, we relied on

information obtained from the market interest rate data provided by Barclays Capital (formerly Lehman Brothers), Goldman Sachs, Deutsche Bank, UBS, Merrill Lynch, JP Morgan, Thomson Financial, US Bancorp, and Bloomberg; trade data available from Bloomberg and Municipal Securities Rulemaking Board; and asset appropriate credit transition matrices and recovery rates for any non-government guaranteed assets as provided by Standard & Poor’s, Moody’s, Fitch, and Standard & Poor’s J.J. Kenny PERFORM Municipal Index.

 

The fair value model calculated market-required rates of return that included a risk-free interest rate and a credit spread. The model discounted the expected coupon rates at the calculated required rate of return to arrive at the price. The model used the market data most recently available as of the valuation date. The cash flows for each security depend on the contractual terms of the security. We estimated the coupon rates for each of the securities by a regression analysis in which the dependent variable was the hypothetical monthly calculated maximum rate over the previous five years of successful auctions and the independent variable was the swap rate. The regression relationship and the current swap rate were used to estimate the future coupon rate. The credit adjustment to the discount rate was calculated as the difference between two interest rates, mainly the interest rate index provided by an investment bank, Barclays Capital or UBS, which was designed to reflect the risk of the security, subtracted from the coupon rate for the most recent successful auction. This credit adjustment was then added to the current value of the index to create a discount rate. We did not use broker quotes or pricing services as the basis for fair value estimate of any ARS.

 

The valuation model also took into effect the counterparty credit risk and lack of marketability effect in arriving at the fair value of the ARS. We estimated the effect of the counterparty credit risk adjustment and the amount of unrealized gain or loss that would affect the consolidated statement of operations and comprehensive income on account of improvement or decline in counterparty credit rating and concluded it was not material as of December 31, 2008.

 

Reflecting the settlement rights offer from UBS, we assumed the remaining life of our investment in ARS to be two years as of December 31, 2008. We indentify the expected life of ARS, an input in the estimate of fair value, as one of the key elements to measure the sensitivity of the fair value of ARS. A change in the expected life from two years to four years would result in a $2.2 million decrease in fair value of ARS outstanding as on December 31, 2008. We measured sensitivity for a range of two to four years in line with exercise period available under the UBS settlement agreement for par value redemption.

 

Fair value estimate for Settlement Rights under UBS agreement

 

We voluntarily adopted the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115 (SFAS 159), which permits entities to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis, to record the settlement rights related to the auction rate securities at fair value. Accordingly, we recorded $2.8 million within other assets in the consolidated balance sheet as of December 31, 2008 for the fair value of the settlement rights and the corresponding amount as a gain within other expense, net in the consolidated statements of operations and comprehensive income. Subsequent changes in the initial recognition of the fair value of settlement rights will be recorded as other income (loss) in the statement of operations and comprehensive income. The fair value estimate of the settlement rights has been derived from the par value of our investment in ARS and the fair value of ARS as on the recognition date, since the settlement rights obligate UBS to redeem the ARS at par.

 

Revenue Recognition

 

Collaboration and License Agreements

 

Our primary sources of revenue include up-front payments, product development milestone payments, reimbursements of research and development expenses, reimbursement of co-promotion costs related to our specialty sales force and miscellaneous marketing activities, and product royalties. We recognize revenue from these sources in accordance with Staff Accounting Bulletin, or SAB, 104, Revenue Recognition, Emerging Issues Task Force, or EITF, Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, and EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21. The application of EITF 00-21 requires subjective analysis and requires us to make estimates and assumptions about whether deliverables within

multiple-element arrangements are separable from the other aspects of the contractual arrangement into separate units of accounting and, if so, to determine the fair value to be allocated to each unit of accounting.

 

We evaluated the multiple deliverables within our joint collaboration and license agreement and the related supplemental agreement with Takeda in accordance with the provisions of EITF 00-21 to determine whether our deliverables have value to Takeda on a stand-alone basis and whether objective reliable evidence of fair value of the undelivered items exists. We separately evaluate deliverables that meet these criteria for the purposes of revenue recognition. We combine deliverables that do not meet these criteria and account for them as a single unit of accounting.

 

In accordance with EITF 00-21, we recognized the cash flows associated with the individual units of accounting from the joint collaboration and license agreement as revenue using a time-based model that recognizes the revenue ratably over the period in which we complete our performance requirements. However, revenue is limited to amounts that are non-refundable and that Takeda is contractually obligated to pay. With respect to the portion of the up-front payment we attributed to our obligation to participate in joint committees with Takeda, which we present as collaboration revenue, the performance period is the 16-year term of the collaboration agreement. With respect to the remainder of the up-front payment, as well as the product development milestone payments and the reimbursement of research and development expenses, all of which we present as research and development revenue, the performance period is the estimated development period for Amitiza to treat chronic idiopathic constipation and irritable bowel syndrome with constipation. The performance period was completed in June 2007 as evidenced by the filing with the FDA of a supplement to our existing NDA for Amitiza relating to the treatment of irritable bowel syndrome with constipation. We have determined that we are acting as a principal under the collaboration agreement and, as such, we record these amounts on a gross basis as collaboration revenue and as research and development revenue.

 

We have other obligations with Takeda to perform research and development activities, for which Takeda reimburses us after the services have been performed. We recognize these reimbursable costs as research and development revenue using a similar time-based model over the estimated performance period. The research and development revenue for these obligations is limited to the lesser of the actual reimbursable costs incurred or the straight-line amount of revenue recognized over the estimated performance period. In cases where milestone payments are received after the completion of the associated development period, we recognize revenue upon completion of the performance obligation. Revenues are recognized for reimbursable costs only if those costs are supported by an invoice or final contract with a vendor.

 

Reimbursements of co-promotion costs under the supplemental agreement with Takeda, including costs associated with our specialty sales force and miscellaneous marketing activities, are recognized as co-promotion revenue as the related costs are incurred and Takeda becomes contractually obligated to pay the amounts. We have determined that we are acting as a principal under the supplemental agreement and, as such, we record reimbursements of these amounts on a gross basis as co-promotion revenue.

 

Product royalty revenue is based on third-party sales of licensed products. We record these amounts 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.

 

We do not immediately recognize as revenue option fees received for other potential joint collaboration and license agreements with Takeda because the transactions do not represent a separate earnings process. Our policy is to recognize revenue immediately upon expiration of the option or to commence revenue recognition upon exercise of the option and continue recognition over the estimated performance period because we will have contingent performance obligations if and when the options are exercised. We record option fees as contract revenue when they are recognized.

 

We recognize contract revenue related to development activities with related parties under the time-based method and we recognize contract revenue related to consulting activities with related parties as performance is rendered. We record cost-sharing payments received in advance as deferred revenue and recognize these payments as revenue over the applicable clinical trial period.

Accrued Research and Development Expenses

 

As part of our process of preparing our consolidated financial statements, we are required to estimate an accrual for research and development expenses. This process involves reviewing and identifying services which have been performed by third parties on our behalf and determining the value of these services. Examples of these services are payments to clinical investigators and contracted service organizations. In addition, we make estimates of costs incurred to date but not yet invoiced to us in relation to external contract research organizations and clinical site costs. We analyze the progress of clinical trials, including levels of patient enrollment, invoices received and contracted costs, when evaluating the adequacy of the accrued liabilities for research and development. We must make significant judgments and estimates in determining the accrued balance in any accounting period.

 

Stock-Based Compensation

 

On January 1, 2006, we adopted SFAS 123(R) Share Based Payments, or SFAS 123(R) using the modified prospective method of implementation. According to the modified prospective method, we have been recognizing compensation expense for all share-based payment awards granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

 

For recording our stock-based compensation expense under SFAS 123(R), we have chosen to use:

 

 

We account for transactions with non-employees in which services are received in exchange for equity instruments under EITF 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring or in Conjunction with Selling Goods or Services. Under this guidance, the transactions are based on the fair value of the services received from the non-employees or the fair value of the equity instruments issued, whichever is more reliably measured. The three factors which most affect stock-based compensation are the fair value of the common stock underlying stock options for which stock-based compensation is recorded, the vesting term of the options and the volatility of such fair value of common stock. Accounting for these equity instruments requires us to determine the fair value of the equity instrument granted or sold. If our estimates of the fair value of these equity instruments are too high or too low, it would have the effect of overstating or understating stock-based compensation expenses.

 

Prior to the completion of our initial public offering in August 2007, our board of directors determined the fair value of our class A common stock for stock option awards given the lack of an active market for our class A common stock. In establishing the estimates of fair value, our board of directors considered the guidance set forth in the AICPA Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, and made retrospective determinations of fair value. The board of directors gave significant consideration to the price of the class A common stock sold to unrelated third parties in the first half of 2006 in determining fair value for purposes of the stock options granted to employees shortly after the sales occurred.

 

Determining the fair value of our class A common stock required making complex and subjective judgments. Our approach to valuation was based on a discounted future cash flow approach that used our estimates of revenue, driven by assumed market growth rates, and estimated costs as well as appropriate discount rates. These estimates were consistent with the plans and estimates that we used to manage our business. There was inherent uncertainty in making these estimates.

Income Taxes

 

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. We follow SFAS No. 109, Accounting for Income Taxes. This process requires us to estimate our actual current tax exposure while assessing our temporary differences resulting from the differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences have resulted in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We consider forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate, and prudent and feasible tax planning strategies in determining the need for a valuation allowance. Considerable judgment is involved in developing such estimates. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, we would charge an adjustment to earnings for the deferred tax assets in the period in which we make that determination. Likewise, if we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance. In order for us to realize our deferred tax assets we must be able to generate sufficient taxable income in the tax jurisdictions in which our deferred tax assets are located.

 

Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance recorded against our deferred tax assets. We recorded a valuation allowance of $5.7 million and $10.8 million as of December 31, 2008 and 2007, respectively, which resulted in a net deferred tax asset of $5.0 million and $639,000 as of December 31, 2008 and 2007, respectively. The increase in the net deferred tax asset is due primarily to the reversal of valuation allowance on the remaining net deferred tax assets in the United States. Significant future events, including continued success in commercialization of products in U.S. markets, regulatory approvals for products in international markets, not in our control could affect our future earnings potential and consequently the amount of deferred tax assets that will be utilized. We determined the amount of the valuation allowance based on our estimates of income in the jurisdictions in which we operate over the periods in which the related deferred tax assets are recoverable.

 

As of December 31, 2008, we had foreign net operating loss carry forwards of $14.4 million. The foreign net operating loss carry forwards will begin to expire on December 31, 2011.

 

On January 1, 2007, we adopted Financial Accounting Standards Board, or FASB, Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN 48. FIN 48 requires application of a more likely than not threshold to the recognition and derecognition of uncertain tax positions. If the recognition threshold is met, FIN 48 permits us to recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is more than 50 percent likely to be realized upon settlement.

 

We have recorded a non-current income tax liability of $517,000 for uncertain tax positions as of December 31, 2008. The amount represents the aggregate tax effect of differences between tax return positions and the amounts otherwise recognized in our consolidated financial statements, and are reflected in other liabilities in the accompanying consolidated balance sheets. The liability for uncertain tax positions as of December 31, 2008 mainly pertains to our interpretation of nexus in certain states related to certain revenue sources for state income tax purposes.

 

We recognize interest and penalties accrued related to uncertain tax positions as a component of the income tax provision. There were no interest and penalties recorded in 2008. We have 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.

 

We are still open to examination by tax authorities from 2005 forward, although research and experimentation tax attributes that were generated prior to 2005 may still be adjusted upon examination by tax authorities. We are currently under examination for 2005, 2006 and 2007 by the U.S. tax authorities.

Related Party Transactions

 

As part of our operations, we enter into transactions with our affiliates. At the time of the transaction, we estimate the fair market value of the transaction based upon estimates of net present value or comparable third party information. For material transactions with our foreign subsidiaries and affiliates, we have evaluated the terms of transactions similar to those that would have prevailed had the entities not been affiliated.

 

Founders’ Awards

 

On June 19, 2007, the Compensation Committee of our board of directors authorized a one-time stock and cash award to each of our founders, Drs. Ueno and Kuno. These awards were granted on June 29, 2007 when the founders agreed to their terms and were settled on August 2, 2007 upon the effectiveness of our 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 our 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.

 

We determined the estimated fair value of these founders’ awards, totaling $10.2 million on grant date, using the Black-Scholes-Merton option pricing formula, as allowed under SFAS 123(R). For the six months ended June 30, 2007, we 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 would then be adjusted based upon the final cash settlement amount, but the equity portion was fixed upon the grant date.

 

When the initial public offering was completed in August 2007, the awards were settled and 401,133 shares of class A common stock were issued to the founders. In addition, as a result of the lower public offering price compared to the estimated public offering price at June 30, 2007, we recorded an adjustment of $1.0 million to reduce the amount of expense and related cash portion of the awards, which was paid to the founders.

 

Results of Operations

 

Comparison of years ended December 31, 2008 and December 31, 2007

 

Revenues

 

The following table summarizes our revenues for the years ended December 31, 2008 and 2007:

 

Total revenues were $112.1 million in 2008 compared to $91.9 million in 2007, an increase of $20.2 million or 22.0%.

 

Research and development revenue

 

Research and development revenue was $72.3 million in 2008 compared to $59.4 million in 2007, an increase of $12.9 million or 21.7%. This increase was primarily the result of the $50.0 million research and development milestone payment earned from Takeda in 2008 upon the FDA’s approval of the sNDA of Amitiza for irritable bowel syndrome with constipation as compared to the $30.0 million development milestone payment earned in 2007 when the sNDA was filed, partially offset by a reduction in research and development revenue related to reimbursements for certain ongoing trials during the year ended December 31, 2008.

 

The research and development revenue for 2008 of $22.3 million as reimbursement from Takeda relates to the following three ongoing activities during the year: post-marketing studies to evaluate the safety of Amitiza in patients with renal and hepatic impairment, phase 4 clinical trials of Amitiza for the treatment of chronic idiopathic constipation in pediatric patients and clinical trials of Amitiza for the treatment of opioid-induced bowel dysfunction. The research and development revenue in 2007 includes $21.7 million towards cost reimbursement for research and development payments from Takeda and $7.7 million in upfront payments and additional milestone payments associated with the completion of development of Amitiza which were recognized ratably over the performance period which was completed in June 2007.

 

Product royalty revenue

 

Product royalty revenue represents royalty revenue we earned from Takeda on net sales of Amitiza. In 2008, we recognized $34.4 million of product royalty revenue compared to $27.5 million in 2007, an increase of $6.9 million or 25.1%, reflecting increased sales of Amitiza. The increase reflects the continuing acceptance by patients and physicians of Amitiza 24 mcg for the treatment of chronic idiopathic constipation in adults and sales of Amitiza 8 mcg for irritable bowel syndrome with constipation in adult women, which became available in the second quarter of 2008.

 

Co-promotion revenue

 

Co-promotion revenues represent reimbursement by Takeda of co-promotion costs for our specialty sales force and costs associated with miscellaneous marketing activities in connection with the commercialization of Amitiza. In 2008, we recognized $4.8 million of co-promotion revenues towards reimbursement of sales force costs. In 2007, we recognized $4.4 million as co-promotion revenues, of which approximately $0.1 million was for reimbursement of costs for miscellaneous marketing activities and $4.3 million was for reimbursement of sales force costs.

 

Research and Development Expenses

 

The following summarizes our research and development expenses for the years ended December 31, 2008 and 2007:

 

Total research and development expenses in 2008 were $46.2 million compared to $31.7 million in 2007, an increase of $14.5 million or 45.7%. These costs primarily reflect our ongoing clinical development programs of Amitiza for the treatment of opioid-induced bowel dysfunction and chronic idiopathic constipation in Japan and cobiprostone for the treatment of non-steroidal anti-inflammatory drug-induced ulcers and portal hypertension in patients with liver cirrhosis, as well as preclinical and basic development costs associated with SPI-017. In 2008, we also incurred filing and data purchase costs of approximately $2.5 million, which were necessary to submit our European MAAs for lubiprostone, 24 micrograms, for the indication of chronic idiopathic constipation in adults.

 

General and Administrative Expenses

 

The following summarizes our general and administrative expenses for years ended December 31, 2008 and 2007:

 

 

General and administrative expenses were $14.4 million in 2008 compared to $21.4 million in 2007, a decrease of $7.0 million or 32.8%. The decrease in the general and administrative expenses for 2008 was primarily the result of the absence of an expense of $9.2 million that was recorded in 2007 for a one-time cash and stock-based award granted to our founders for stock options previously granted and terminated, offset by an increase in expenses associated with our new office space in the United States and an increase in overall cost associated with the compliance and regulatory requirements of being a publicly traded company with international operations.

 

Selling and Marketing Expenses

 

Selling and marketing expenses represent costs we incur to co-promote Amitiza, including salaries, benefits and related costs for our sales force and other sales and marketing personnel, costs of market research and analysis and other selling and marketing expenses. Selling and marketing expenses were $10.9 million in 2008 compared to $13.5 million in 2007, a decrease of $2.6 million or 19.1%. This decrease was primarily due to reduced marketing expense in the long term care market and cost savings related to utilization of our own internal dedicated sales force to provide Amitiza to patients in long-term care facilities, medical schools and university hospitals.

 

Product Royalties — Related Parties

 

Product royalties — related parties expense represent royalty payments to our affiliate Sucampo AG based on net sales of Amitiza. In 2008, our product royalty expense was $6.0 million compared to $4.9 million in 2007, an increase of $1.1 million, or 23.6%, which was consistent with the increase of product royalty revenue of 25.1%.

 

Milestone Royalties — Related Parties

 

Milestone royalties — related parties expense was $3.5 million in 2008 compared to $2.0 million in 2007, a decrease of $1.5 million, or 76.6%. In 2008, we paid Sucampo AG a $1.0 million milestone in connection with our European MAA’s filed in February 2008. As a result of our sNDA approval for Amitiza to treat irritable bowel syndrome with constipation, we paid SAG $2.5 million, reflecting 5% of the $50.0 million development milestone payment that we received from Takeda in May 2008. In 2007, we paid Sucampo AG $1.5 million reflecting the 5%

we owed them for the $30.0 million development milestone earned from Takeda during that period and a $0.5 million milestone for the initiation of a phase 2 trial in Japan.

 

Non-Operating Income and Expense

 

The following table summarizes our non-operating income and expense for the years ended December 31, 2008 and 2007:

 

 

Interest income during 2008 and 2007 remained flat as interest earned on higher investment balances during 2008 as compared to 2007 was offset by a decrease in yield earned by our investments during 2008 as interest rates declined generally and as the mix of our investment portfolio moved from ARS to lower interest rate U.S. government securities during the year.

 

Other expenses primarily include an unrealized loss of $3.2 million on trading securities offset by a $2.8 million unrealized gain on settlement rights on our investments in auction rate securities.

 

Income Taxes

 

For the years ended December 31, 2008 and 2007, our consolidated effective tax rate was 24.7% and 37.3%, respectively. For the years ended December 31, 2008 and 2007, we recorded a tax provision of $8.2 million and $7.8 million, respectively. The decrease in the effective tax rate in 2008 from 2007 was attributable to the release of valuation allowance on our U.S. deferred tax assets largely due to the recognition of $50.0 million in development milestone revenue during 2008, as well as an increase in projected profits in the United States. As of December 31, 2008, our remaining valuation allowance against our deferred tax assets was $5.7 million solely relating to foreign jurisdictions.

 

Comparison of years ended December 31, 2007 and December 31, 2006

 

Revenues

 

The following table summarizes our revenues for the years ended December 2007 and 2006:

 

 

Total revenues were $91.9 million in 2007 compared to $59.3 million in 2006, an increase of $32.6 million, or 55.0%. This increase was primarily due to an increase in payments received from Takeda for research and development services performed by us and product royalties from Amitiza sales.

 

Research and development revenue was $59.4 million in 2007 compared to $46.4 million in 2006, an increase of $13.0 million, or 28.0%. This increase was due to the recognition of the $30.0 million research and development milestone payment for the completion of our development of Amitiza to treat chronic idiopathic constipation and irritable bowel syndrome with constipation and the recognition of payments previously received from Takeda,

offset in part by a decline of $17.0 million of research and development revenue reflecting the recognition of Amitiza -related deferred revenue previously received from Takeda for only six months in 2007 compared with twelve months in 2006. We recognized revenue for this development work ratably over the estimated performance period associated with the development of Amitiza, which was completed in June 2007.

 

The specific revenue streams associated with research and development revenue for the years ended December 31, 2007 and 2006 were as follows:

 

 

We began to recognize product royalty payments from Takeda as revenue in the second quarter of 2006 following the product launch of Amitiza. In 2007, we recognized $27.5 million of product royalty revenue compared to $6.6 million in 2006, reflecting increased sales of Amitiza.

 

We began to receive reimbursement of costs for our sales force in the second quarter of 2006 following the product launch of Amitiza. In 2007, we recognized $4.4 million of co-promotion revenues, of which approximately $158,000 was for reimbursement of costs for miscellaneous marketing activities and approximately $4.3 million was for reimbursement of sales force costs. In 2006, we recognized $4.2 million as co-promotion revenues, of which approximately $291,000 was for reimbursement of costs for miscellaneous marketing activities and $3.5 million was for reimbursement of sales force costs.

Contract revenue — related parties represents reimbursement of costs incurred by us on behalf of affiliated companies for research and development consulting, patent maintenance and certain administrative costs. These revenues are recognized in accordance with the terms of the contract or project to which they relate. We had no contract revenue in 2007 compared to $1.5 million in 2006. Contract revenue represents amounts released from previously deferred revenue that we recognized upon the expiration in January 2006 of the option we had previously granted to Takeda for joint development and commercialization rights for Amitiza in Europe, Africa and the Middle East.

 

Research and Development Expenses

 

The following summarizes our research and development expenses for the years ended December 31, 2007 and 2006:

 

 

Total research and development expenses in 2007 were $31.7 million compared to $19.2 million in 2006, an increase of $12.5 million or 65.1%. The higher costs in 2007 reflect the significant research and development expenses incurred by us during that period in connection with the filing of the sNDA for the treatment of irritable bowel syndrome with constipation; the initiation of post-marketing safety studies in pediatric patients, in patients with renal impairment and in patients with hepatic impairment; the initiation of phase 3 studies for opioid-induced bowel dysfunction; and the initiation of a phase 2 study of NSAID-induced ulcers. In 2006, our research and development expenses were primarily those associated with the ongoing phase 3 clinical trials of Amitiza for the treatment of irritable bowel syndrome with constipation. In September 2007, we enrolled our first patient in a phase 3 study for opioid-induced bowel dysfunction and our first patient in a multi-center phase 2 study of NSAID-induced ulcers.

 

General and Administrative Expenses

 

The following summarizes our general and administrative expenses for years ended December 31, 2007 and 2006:

 

General and administrative expenses were $21.4 million in 2007 compared to $11.7 million in 2006, an increase of $9.7 million or 83.1%. This increase was due primarily to the founders’ stock-based award of $9.2 million granted in June 2007, comprising of $6.1 million non-cash compensation expense and $3.1 million in cash settlement expense, offset in part by the decline in stock-based compensation expenses from the $2.7 million recorded in the prior year. This increase also reflected increases in operational headcount, rent for additional leased office space, lease loss related to the abandonment of our former office in Bethesda, Maryland in 2007 and additional costs associated with being a publicly-traded company.

 

We recorded a cumulative out-of-period adjustment of approximately $358,000 in 2007 to reduce an overstatement of additional paid-in capital and general administrative expenses that had been recorded as of and for the year ended December 31, 2006 in connection with employee stock options awarded in 2006. The error resulted from applying the incorrect contractual term for to the 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 September 30, 2006.

 

Selling and Marketing Expenses

 

Selling and marketing expenses were $13.5 million in 2007 compared to $11.2 million in 2006, an increase of $2.3 million or 20.5%. This increase was due to increased costs for market research and analysis, marketing and promotional materials and other costs, reflecting the operation of our sales and marketing function for twelve months in 2007 compared to only nine months in 2006.

 

Product Royalties — Related Parties

 

We began to incur product royalty expenses for net sales of Amitiza in the second quarter of 2006 following the product launch of Amitiza. In 2007, we expensed $4.9 million in product royalties — related parties compared to $1.2 million in 2006, reflecting higher product sales in 2007.

 

Milestone Royalties — Related Parties

 

Milestone royalties — related parties expense were $2.0 million and $1.3 million in 2007 and 2006, respectively. These royalties were paid to Sucampo AG, reflecting the 5% we owed them for the $30.0 million development milestone earned from Takeda during that period and a $500,000 milestone for the initiation of a phase 2 trial in Japan. The milestone royalties — related parties of $1.3 million for the year ended December 31, 2006 were paid to Sucampo AG, reflecting the 5% we owed them for the $20.0 million development milestone payment we received from Takeda during that period, and a $250,000 milestone payment for regulatory approval of Amitiza.

 

Non-Operating Income and Expense

 

The following table summarizes our non-operating income and expense for the years ended December 31, 2007 and 2006:

 

 

Interest income was $2.5 million in 2007 compared to $2.0 million in 2006, an increase of $0.5 million or 22.2%. The increase was primarily due to an increase in the funds available for investment as a result of our receipt of development milestone payments from Takeda in June 2007 and the closing of our initial public offering in

August 2007. Interest expense was nil in 2007 compared to $90,000 in 2006, a decrease of $90,000. This decrease reflected our repayment in full in June 2006 of related party debt instruments.

 

Income Taxes

 

For the years ended December 31, 2007 and 2006, our consolidated effective tax rate was 37.3% and 29.0%, respectively. We recorded a tax provision of $7.8 million for 2007 and a tax benefit of $4.9 million for 2006. The increase in the effective tax rate in 2007 from 2006 was due to a partial release of the valuation allowance on the U.S. deferred tax assets in 2006 that did not recur in 2007. As of December 31, 2007, our remaining valuation allowance against our deferred tax assets was $10.8 million.

 

Reportable Geographic Segments

 

We have determined that we have three reportable geographic segments based on our method of internal reporting, which disaggregates business by geographic location. These segments are the United States, Europe and Japan. We evaluate the performance of these segments on the basis of income from operations. The following is a summary of financial information by reportable segment.

 

 

Liquidity and Capital Resources

 

Sources of Liquidity

 

We require cash principally to meet our operating expenses. Historically, we have financed our operations with a combination of up-front payments, milestone and royalty payments and research and development expense reimbursements received from Takeda and other parties, private placements of equity securities and our initial public offering.

 

Our cash, cash equivalents and investments consist of the following:

 

 

Our cash and cash equivalents are deposits in operating accounts and highly liquid investments with an original maturity at time of purchase of 90 days or less.

As of December 31, 2008, our short term investments consist of money market funds, U.S. Treasury notes and bills which have short term maturities. Our non-current investments primarily consist of investments in ARS.

 

ARS are long-term debt instruments that provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined calendar intervals, generally every seven to 49 days. This mechanism generally allows existing investors to roll-over their holdings and continue to own their respective securities or liquidate their holdings by selling their securities at par value. The disruption of liquidity in short-term fixed income markets resulting in failed auctions prevented us from liquidating certain holdings of ARS during the year.

 

During October 2008, we accepted the settlement rights offer from the broker UBS, AG of our ARS. This right permits us to require UBS to purchase our ARS at par value between June 30, 2010 and July 2, 2012. We do not anticipate having to sell these securities in order to operate our business before the expected redemption dates.

 

To conserve cash and more closely align our spending towards our strategic objectives, we implemented cost reduction initiatives in early 2009, including a workforce reduction and a refocusing of our research and development plans. We expect these initiatives will result in reduced costs of approximately $3.0 million during 2009. However, there is no assurance that we will be successful in achieving these cost savings if actual spending varies from our budget, or that these cost savings will not hurt our business and our ability to pursue our development and commercialization strategies.

 

Cash Flows

 

The following table summarizes our cash flows for the years ended December 31, 2008, 2007 and 2006:

 

 

Year ended December 31, 2008

 

Net cash provided by operating activities was $37.2 million for the year ended December 31, 2008. This reflected net income of $25.0 million, which included a non-cash unrealized loss on trading securities of $3.2 million, an increase in deferred revenue of $14.0 million offset by a non cash deferred tax benefit of $4.4 million, a non-cash unrealized gain on settlement rights on auction rate securities of $2.8 million and an increase in prepaid and income tax receivable and payable, net of $1.8 million. The increase in deferred revenue primarily related to the prepayments received from Takeda towards research and development expense reimbursement and $3.9 million of additional deferral of revenue due to change in the estimated development period of Amitiza for opioid-induced bowel dysfunction.

 

Net cash used in investing activities of $52.5 million for the year ended December 31, 2008 primarily reflected our net purchases of investments as a result of our investment of the $50.0 million milestone payment received from Takeda during the year.

 

Net cash provided by financing activities of $878,000 for the year ended December 31, 2008 resulted mainly from the exercise of stock options and proceeds from the employee stock purchase plan during the year.

 

Year ended December 31, 2007

 

Net cash provided by operating activities was $5.6 million for the year ended December 31, 2007. This reflected net income of $13.2 million, which included non-cash deferred tax provision of $4.3 million and non-cash

stock-based compensation of $6.7 million, offset by an increase in product royalties receivable of $6.6 million and in accounts receivable of $5.9 million and a decrease in deferred revenue of $11.0 million. The decrease in deferred revenue primarily related to the amortization of deferred research and development revenue over the performance period of the development of Amitiza.

 

Net cash used in investing activities was $33.8 million for the year ended December 31, 2007. This primarily reflected our purchases of short-term investments and of property and equipment associated with the move of our offices in the United States in July 2007 offset by proceeds from the sale of short-term investments.

 

Net cash provided by financing activities was $31.3 million for the year ended December 31, 2007. This reflected the net proceeds from the issuance of class A common stock in our initial public offering, which was consummated in August 2007. We had prepaid $3.1 million of offering expenses prior to 2007.

 

Year ended December 31, 2006

 

Net cash used in operating activities was $10.9 million for the year ended December 31, 2006. This reflected net income of $21.8 million, which included a non-cash charge of $3.3 million of stock-based compensation expense. We also had a decrease in deferred tax provision of $4.0 million and a decrease in deferred revenue of $26.8 million. The decrease in deferred revenue primarily related to the amortization of deferred research and development revenue over the performance period of the development of Amitiza.

 

Net cash used in investing activities was $1.4 million for the year ended December 31, 2006. This reflected our purchases of short-term investments and property and equipment of $2.5 million, offset in part by proceeds received from sales and maturities of short-term investments of $1.3 million.

 

Net cash provided by financing activities was $17.4 million for the year ended December 31, 2006. This reflected $23.9 million in net proceeds raised in a private placement sale of 2,398,759 shares of class A common stock, $1.2 million in funds received from borrowings under related party debt instruments, $2.9 million of payments incurred for our completed initial public offering and $4.8 million of repayments under related party debt instruments.

 

Commitments and Contingencies

 

As of December 31, 2008, our principal outstanding contractual obligations related to our office leases in Bethesda, Maryland, England and Japan. The following table summarizes these significant contractual obligations at December 31 for the indicated year:

 

 

The above table does not include:

 

 

 

 

 

Funding Requirements

 

We will need substantial amounts of capital to continue growing our business. We will require this capital, among other things, to:

 

 

The timing of these funding requirements is difficult to predict due to many factors, including the outcomes of our research and development programs and when those outcomes are determined, the timing of obtaining regulatory approvals and the presence and status of competing products. Our capital needs may exceed the capital available from our future operations, collaborative and licensing arrangements and existing liquid assets. Our future capital requirements and liquidity will depend on many factors, including, but not limited to: