S-1/A 1 w34771a8sv1za.htm SUCAMPO PHARMACEUTICALS, INC sv1za
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As filed with the Securities and Exchange Commission on July 17, 2007
Registration No. 333-135133
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Amendment No. 8
to
Form S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
 
 
 
 
SUCAMPO PHARMACEUTICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
         
Delaware   2834   13-3929237
(State or Other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (IRS Employer
Identification Number)
 
 
 
 
4520 East-West Highway, Suite 300
Bethesda, Maryland 20814
(301) 961-3400
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)
 
 
 
 
Ryuji Ueno, M.D., Ph.D., Ph.D,
Chief Executive Officer
Sucampo Pharmaceuticals, Inc.
4520 East-West Highway, Suite 300
Bethesda, Maryland 20814
(301) 961-3400
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)
 
 
 
 
Copies to:
 
     
Brent B. Siler, Esq.
Wilmer Cutler Pickering Hale and Dorr LLP
1875 Pennsylvania Ave., NW
Washington, District of Columbia 20006
(202) 663-6000
(202) 663-6363 (fax)
  Jeffrey D. Karpf, Esq.
Cleary Gottlieb Steen & Hamilton LLP
One Liberty Plaza
New York, New York 10006
(212) 225-2000
(212) 225-3999 (fax)
 
Approximate date of commencement of proposed sale to public:  As soon as practicable after this Registration Statement becomes effective.
 
 
 
If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  o
 
If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o                 
 
If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering.  o                 
 
If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering.  o                 
 
 
 
 
CALCULATION OF REGISTRATION FEE
 
                                         
            Proposed Maximum
    Proposed Maximum
    Amount of
Title of Each Class of
    Amount
    Offering
    Aggregate
    Registration
Securities to be Registered     to be Registered(1)     Price per Share(2)     Offering Price(2)     Fee(3)
Class A Common Stock, $0.01 par value per share
      4,312,500 shares       $ 16.00       $ 69,000,000       $ 2,118  
                                         
 
(1)  Includes 562,500 shares that the underwriters have the option to purchase to cover over-allotments, if any.
 
(2)  Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) under the Securities Act of 1933, as amended.
 
(3)  Previously paid.
 
 
 
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.
 


Table of Contents

The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and is not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.
 
     
PRELIMINARY PROSPECTUS (Subject to Completion)   Dated July 17, 2007
     
 
3,750,000 Shares
 
 
(SUCAMPO LOGO)
 
Class A Common Stock
 
 
This is an initial public offering of shares of our class A common stock. We are offering 3,125,000 shares and a selling stockholder is offering 625,000 shares of our class A common stock. We will not receive any proceeds from the sale of shares by the selling stockholders. Prior to this offering, there has been no public market for our class A common stock. We have applied for quotation of our class A common stock on The NASDAQ Global Market under the symbol “SCMP”. We expect that the public offering price will be between $14.00 and $16.00 per share.
 
Our business and an investment in our class A common stock involve significant risks. These risks are described under the caption “Risk Factors” beginning on page 8 of this prospectus.
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
 
 
 
                 
    Per Share   Total
 
Public offering price
  $       $    
                 
Underwriting discounts and commissions
  $       $    
                 
Proceeds, before expenses, to Sucampo Pharmaceuticals, Inc.
  $       $    
                 
Proceeds, before expenses, to selling stockholders
  $       $  
 
The underwriters may also purchase up to an additional 562,500 shares from one of the selling stockholders at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover overallotments.
 
The underwriters expect to deliver the shares against payment on          , 2007.
 
 
Cowen and Company
 
CIBC World Markets
 
Leerink Swann & Company
 
 
          , 2007


 

 
You should rely only on the information contained in this prospectus. We and the selling stockholders have not, and the underwriters have not, authorized anyone to provide you with information or information different from that contained in this prospectus. We and the selling stockholders are offering to sell, and seeking offers to buy, shares of our class A common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of shares of our common stock. In this prospectus, unless otherwise stated or the context otherwise requires, references to “Sucampo,” “we,” “us,” “our” and similar references refer to Sucampo Pharmaceuticals, Inc. and its consolidated subsidiaries, Sucampo Pharma Europe Ltd. and Sucampo Pharma, Ltd.
 
SUCAMPO® and AMITIZA® are our registered trademarks and our logo is our trademark. Each of the other trademarks, trade names or service marks appearing in this prospectus belongs to its respective holder.
 
 
TABLE OF CONTENTS
 
         
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  F-1
 Exhibit 3.1A
 EX-10.37
 EX-23.1
 EX-24.4
 
 
NOTICE TO INVESTORS
 
For investors outside the United States:  Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus.


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SUMMARY
 
This summary highlights information contained elsewhere in this prospectus. This summary may not contain all of the information that is important to you. Before investing in our class A common stock, you should read this prospectus carefully in its entirety, especially the risks of investing in our class A common stock that we discuss under “Risk Factors,” and our consolidated financial statements and related notes beginning on page F-1.
 
Sucampo Pharmaceuticals, Inc.
 
Sucampo Pharmaceuticals, Inc. is an emerging pharmaceutical 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. The therapeutic potential of prostones was first identified by one of our founders, Dr. Ryuji Ueno. We believe that most prostones function as activators of cellular ion channels and, as a result, may be effective at promoting fluid secretion and enhancing cell protection, which may give them wide-ranging therapeutic potential, particularly for age-related diseases. We are focused on developing prostones with novel mechanisms of action for the treatment of gastrointestinal, respiratory, vascular and central nervous system diseases and disorders for which there are unmet or underserved medical needs and significant commercial potential.
 
AMITIZA
 
In January 2006, we received marketing approval from the U.S. Food and Drug Administration, or FDA, for our first product AMITIZA® (lubiprostone) for the treatment of chronic idiopathic constipation in adults. 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, including those over 65 years of age, and that has demonstrated effectiveness for use beyond 12 weeks. 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.
 
We also plan to pursue marketing approval for AMITIZA for additional constipation-related gastrointestinal indications with large, underserved markets. We recently completed two pivotal Phase III clinical trials and a long-term safety trial of AMITIZA for the treatment of irritable bowel syndrome with constipation. Based on the results of these trials, we submitted a supplement to our existing new drug application, or NDA, for AMITIZA to the FDA in June 2007 seeking marketing approval for AMITIZA for the treatment of this indication. In addition, we plan to commence Phase III pivotal clinical trials of AMITIZA for the treatment of opioid-induced bowel dysfunction in the third quarter of 2007.
 
We are party to 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, opioid-induced bowel dysfunction and other gastrointestinal indications in the United States and Canada. We have the right to co-promote AMITIZA along with Takeda in these markets. We and Takeda initiated commercial sales of AMITIZA in the United States for the treatment of chronic idiopathic constipation in April 2006. Takeda is marketing AMITIZA broadly to office-based specialty physicians and primary care physicians. We are complementing 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. We have performed all of the development activities with respect to AMITIZA and Takeda has funded a portion of the cost for these activities. We have retained the rights to develop and commercialize AMITIZA outside the United States and Canada and to develop and commercialize it in the United States and Canada for indications other than gastrointestinal indications.


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Additional Compounds
 
Our additional compounds in development include:
 
  •  SPI-8811 (cobiprostone) for the treatment of ulcers induced by non-steroidal anti-inflammatory drugs, or NSAIDs, portal hypertension, non-alcoholic fatty liver disease, disorders associated with cystic fibrosis and chronic obstructive pulmonary disease. We have completed Phase I trials of SPI-8811 for NSAID-induced ulcers and a Phase II trial in patients with cystic fibrosis. We plan to commence a Phase II clinical trial of SPI-8811 to treat NSAID-induced ulcers in the third quarter of 2007, a Phase II proof of concept study of SPI-8811 in patients with portal hypertension in 2007, and a Phase II trial of SPI-8811 for gastrointestinal disorders associated with cystic fibrosis by the second quarter of 2008. This last Phase II trial is different than the Phase II trial we have already completed for cystic fibrosis. SPI-8811 is in the preclinical stage for other indications.
 
  •  SPI-017 for the treatment of peripheral arterial and vascular disease and 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. We also are developing an oral formulation of SPI-017 for the treatment of Alzheimer’s disease. We plan to commence Phase I clinical trials of the intravenous formulation of SPI-017 and Phase I clinical trials of the oral formulation in 2008.
 
Our Strategy
 
Our goal is to become a leading pharmaceutical company focused on discovering, developing and commercializing proprietary drugs based on prostones to treat diseases and disorders for which there are unmet or underserved medical needs and significant commercial potential. Our strategy to achieve this objective includes the following key elements:
 
  •  Focus on the commercialization of AMITIZA in the United States for the treatment of chronic idiopathic constipation in adults.
 
  •  Develop AMITIZA for the treatment of additional indications and discover, develop and commercialize other prostone product candidates. We believe that our focus on prostones may offer several potential advantages, including:
 
  –  novel mechanisms of action;
 
  –  wide-ranging therapeutic potential;
 
  –  our discovery and development experience with prostones; and
 
  –  patent protection.
 
  •  Target large and underserved markets, with a particular focus on treating indications in the elderly population.
 
  •  Seek marketing approval for AMITIZA and our other product candidates outside the United States.
 
  •  Focus on our core discovery, clinical development and commercialization activities.
 
  •  Grow through strategic acquisitions and in-licensing opportunities.
 
Related-Party Arrangements
 
We hold an exclusive worldwide royalty-bearing license from Sucampo AG, a Swiss patent-holding company, to develop and commercialize AMITIZA and other prostone compounds covered by patents and patent applications held by Sucampo AG. 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. With respect to any prostone compound other than AMITIZA, SPI-8811 and SPI-017, if we have not performed preclinical testing and generated specified pharmacological and toxicity data for such compound during the period that ends on the later of June 30, 2011 or the date upon which our founders, Drs. Sachiko Kuno and Ryuji Ueno, 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 as one for which we intend in good faith to perform the required testing within that extension period.


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We are party to exclusive supply arrangements with R-Tech Ueno, Ltd., or R-Tech, a Japanese pharmaceutical manufacturer, to provide us with clinical and commercial supplies of AMITIZA and clinical supplies of our product candidates SPI-8811 and SPI-017. These arrangements include provisions requiring R-Tech 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.
 
Our two founders, Dr. Kuno and Dr. Ueno, together, directly or indirectly, own all of the stock of Sucampo AG and a majority of the stock of R-Tech. Drs. Kuno and Ueno 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 was, until recently, also an executive officer and director of our company.
 
Recent Developments
 
In June 2007, we submitted a supplement to our existing NDA for AMITIZA to the FDA seeking marketing approval for AMITIZA for the treatment of irritable bowel syndrome with constipation. As a result of this filing, Takeda is required by the terms of our collaboration agreement with them to make a $30.0 million milestone payment to us. We expect to recognize the entire amount of this payment as research and development revenue in the quarter ended June 30, 2007. We will be obligated to pay Sucampo AG $1.5 million, reflecting 5% of this milestone payment. We expect to expense the entire amount of this payment as milestone royalties to related parties in the quarter ended June 30, 2007.
 
For the three months ended June 30, 2007, we estimate that our product royalty revenues were approximately $9.5 million, compared to $2.3 million for the three months ended March 31, 2007, reflecting increased prescriptions for AMITIZA to treat chronic idiopathic constipation. We estimate that we will be obligated to pay Sucampo AG $1.7 million, reflecting 3.2% of AMITIZA net sales for the quarter. We expect to expense the entire amount of this payment as product royalties to related parties in the quarter ended June 30, 2007.
 
In June 2007, the compensation committee of our board of directors authorized a one-time stock and cash award to each of Drs. Kuno and Ueno, which will be settled immediately following this offering. These awards are described in more detail under the caption “Certain Relationships and Related Party Transactions — Special Stock and Cash Awards to Drs. Kuno and Ueno” appearing elsewhere in this prospectus. We also refer to these awards in this prospectus as the founders make-whole awards. These awards will consist of a combination of cash and shares of class A common stock and will be fully vested. The overall value of these awards, as well as the number of shares of class A common stock to be issued as the stock component of the awards, will depend upon the public offering price per share in this offering. Assuming a public offering price of $15.00 per share, the midpoint of the price range set forth on the cover of this prospectus, the aggregate value of these awards would be $10.2 million, consisting of $4.1 million in cash and 407,496 shares of class A common stock. We expect to record general and administrative expense equal to the aggregate value of these awards in our financial statements for the quarter ended June 30, 2007.
 
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.
 
Immediately following the closing of this offering, after giving effect to the assumed issuance of 407,496 shares of class A common stock in connection with the founders make-whole awards, we will have outstanding 15,544,881 shares of class A common stock and 26,191,050 shares of class B common stock. The class B common stock will represent approximately 94% of the combined voting power of our outstanding common stock immediately following this offering. All of the shares of class B common stock are owned by S&R Technology Holdings, LLC, an entity wholly owned and controlled by Drs. Kuno and Ueno. As a result, Drs. Kuno and Ueno 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.


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We will not be authorized to issue additional shares of class B common stock after this offering 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. Kuno and Ueno 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 prospectus, we refer to our authorized class A common stock and class B common stock together as our common stock.
 
Risks Associated With Our Business
 
Our business is subject to numerous risks, as more fully described in the section entitled “Risk Factors” immediately following this prospectus summary. Since our formation, we have incurred significant operating losses and, as of March 31, 2007, we had an accumulated deficit of $22.9 million. We expect to incur additional losses and may never achieve or maintain profitability. Our success depends on the successful commercialization of AMITIZA for the treatment of chronic idiopathic constipation in adults and other indications for which we are developing this drug. We have limited experience commercializing drug products. If we are not successful in making the transition from a pre-commercial stage company to a commercial company, our ability to become profitable will be compromised. We are highly dependent upon the continued service of Dr. Ueno, our chief executive and chief scientific officer, and our other key executives. We depend significantly upon our collaboration with Takeda, and the successful commercialization of AMITIZA will depend to a large degree upon the effectiveness of Takeda’s sales force. Our agreement with Takeda provides that it may be terminated by either party if we fail to receive marketing approval from the FDA for AMITIZA for the treatment of irritable bowl syndrome with constipation and if we and Takeda do not thereafter agree on an alternative development and commercialization strategy. We have no manufacturing capabilities and rely exclusively upon R-Tech for the manufacture of AMITIZA and other prostone product candidates. Our preclinical studies may not produce successful results and our clinical trials may not demonstrate safety and efficacy in humans, which could impair our ability to develop additional indications for AMITIZA and to develop and commercialize other product candidates.
 
Our Corporate Information
 
We were incorporated under the laws of Delaware in December 1996. Our principal executive offices are located at 4520 East-West Highway, Suite 300, Bethesda, Maryland 20814, and our telephone number is (301) 961-3400. In September 2006, we acquired all of the capital stock of two affiliated European and Asian operating companies, Sucampo Pharma Europe Ltd., or Sucampo Europe, and Sucampo Pharma, Ltd., or Sucampo Japan, that were previously under common control with us. Sucampo Europe and Sucampo Japan are now wholly owned subsidiaries of our company.


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The Offering
 
Class A common stock we are offering 3,125,000 shares
 
Class A common stock a selling stockholder is offering   625,000 shares
     Total class A common stock offered
3,750,000 shares
 
Common stock to be outstanding after this offering:
 
  Class A 15,544,881 shares
 
  Class B 26,191,050 shares
     Total 41,735,931 shares
 
Voting rights One vote for each share of class A common stock and ten votes for each share of class B common stock on all matters on which stockholders are entitled to vote.
 
Use of proceeds We estimate that the net proceeds from this offering will be approximately $38.6 million, assuming an initial public offering price of $15.00 per share, after deducting estimated underwriting discounts and commissions and offering expenses payable by us. We expect to use these net proceeds to fund: development activities for AMITIZA, SPI-8811 and SPI-017; expansion of our sales and marketing function; additional clinical trials and sales and marketing efforts by our European and Asian operating subsidiaries; development of other prostone compounds; and working capital, capital expenditures and other general corporate purposes, which may include the acquisition or in-license of complementary technologies, products or businesses. See “Use of Proceeds.” We will not receive any of the proceeds from the sale of shares of our class A common stock by the selling stockholders.
 
Risk factors See “Risk Factors” and the other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our class A common stock.
 
Proposed NASDAQ Global Market symbol SCMP
 
The number of shares of our class A and class B common stock to be outstanding after this offering is based on shares outstanding as of June 30, 2007 and gives effect to the assumed issuance of 407,496 shares of class A common stock in connection with the founders make-whole awards, assuming a public offering price of $15.00 per share, the midpoint of the price range set forth on the cover of this prospectus. The number of shares to be outstanding after this offering excludes:
 
  •  1,150,900 shares of our class A common stock issuable upon the exercise of stock options outstanding as of June 30, 2007 at a weighted average exercise price of $8.29 per share; and
 
  •  an aggregate of 12,750,000 shares of class A common stock reserved for future issuance under our equity compensation plans as of the completion of this offering.
 
Unless otherwise noted, all information in this prospectus:
 
  •  assumes no exercise of the outstanding options described above;
 
  •  assumes no exercise by the underwriters of their option to purchase up to 562,500 shares of class A common stock to cover over-allotments;
 
  •  gives effect to an 8.5-for-1 stock split of our class A common stock and our class B common stock in the form of a stock dividend declared by our board of directors in July 2007; and
 
  •  gives effect to the conversion of all outstanding shares of our preferred stock into an aggregate of 3,213,000 shares of class A common stock, which will occur automatically upon the closing of this offering.


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Summary Consolidated Financial Data
 
The following is a summary of our consolidated financial information. You should read this information together with our consolidated financial statements and the related notes appearing at the end of this prospectus and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus.
 
In September 2006, we acquired all of the capital stock of Sucampo Europe and Sucampo Japan. Accordingly, we have presented our financial statements on a consolidated basis as a merger of entities under common control for all periods presented to reflect this transaction. The pro forma net income per share amounts and the number of shares used in computing pro forma per share amounts give effect to the conversion of our convertible preferred stock into class A common stock.
 
The pro forma as adjusted balance sheet data set forth below gives effect to:
 
  •  our issuance and sale of 3,125,000 shares of class A common stock in this offering at an assumed initial public offering price of $15.00 per share, which is the midpoint of the price range listed on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and offering expenses payable by us; and
 
  •  our payment of $4.1 million in cash immediately following this offering in connection with the founders make-whole awards, assuming a public offering price of $15.00 per share.
 
As discussed in note 2 to our consolidated financial statements, we have restated our consolidated financial statements for the years ended December 31, 2004 and 2005 and the three months ended March 31, 2006 to correct for revenue recognition errors.
 
                                         
    Years Ended December 31,     Three Months Ended March 31,  
    2004     2005     2006     2006     2007  
    (Restated)     (Restated)           (Restated)        
    (in thousands, except per share data)
 
 
Statement of operations data:
                                       
Revenues
  $ 3,839     $ 40,205     $ 59,267     $ 24,168     $ 12,960  
Operating expenses:
                                       
Research and development
    14,036       31,167       16,392       6,120       5,946  
General and administrative
    8,216       7,760       14,587       2,968       2,834  
Selling and marketing
          295       11,103       948       3,231  
Milestone royalties — related parties
    1,000       1,500       1,250       1,250        
Product royalties — related parties
          ——       1,172             410  
                                         
(Loss) income from operations
    (19,413 )     (517 )     14,763       12,882       539  
Total non-operating (expense) income, net
    (56 )     990       2,141       425       318  
                                         
(Loss) income before income taxes
    (19,469 )     473       16,904       13,307       857  
Income tax (provision) benefit
          (789 )     4,897             (341 )
                                         
Net (loss) income
  $ (19,469 )   $ (316 )   $ 21,801     $ 13,307     $ 516  
                                         
Basic net (loss) income per share
  $ (0.60 )   $ (0.01 )   $ .63     $ 0.41     $ 0.01  
                                         
Diluted net (loss) income per share
  $ (0.60 )   $ (0.01 )   $ .63     $ 0.40     $ 0.01  
                                         
Weighted average common shares outstanding — basic
    32,600       32,601       34,383       32,605       34,990  
                                         
Weighted average common shares outstanding — diluted
    32,600       32,601       34,690       33,133       35,429  
                                         
Basic pro forma net income per share
                                  $ .01  
                                         
Diluted pro forma net income per share
                                  $ .01  
                                         
Pro forma weighted average common shares outstanding — basic
                                    38,203  
                                         
Pro forma weighted average common shares outstanding — diluted
                                    38,642  
                                         
 


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    As of March 31, 2007  
          Pro Forma
 
    Actual     As Adjusted  
    (in thousands)  
 
Balance sheet data:
               
Cash and cash equivalents
  $ 15,692     $ 50,211  
Short-term investments
    29,399       29,399  
Working capital
    40,483       75,002  
Total assets
    62,168       96,687  
Total liabilities
    23,253       23,253  
Accumulated deficit
    (22,850 )     (33,037 )
Total stockholders’ equity
    38,915       73,434  

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RISK FACTORS
 
Investing in our class A common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below together with all of the other information included in this prospectus, including the consolidated financial statements and related notes appearing at the end of this prospectus, before deciding to invest in our class A common stock. If any of the following risks actually occur, they may materially harm our business, prospects, financial condition and results of operations. In this event, the market price of our class A common stock could decline and you could lose part or all of your investment.
 
Risks Related to Our Limited Commercial Operations
 
We have historically incurred significant losses and we might not achieve or maintain operating profitability.
 
We initiated commercial sales of our first product, AMITIZA, for the treatment of chronic idiopathic constipation in adults in April 2006, and we first generated product royalty revenue in the quarter ended June 30, 2006. Since our formation, we have incurred significant operating losses and, as of March 31, 2007, we had an accumulated deficit of $22.9 million. Our net losses were $19.5 million in 2004 and $316,000 in 2005. Although we had net income of $21.8 million in 2006 and $516,000 in the first quarter of 2007, this was primarily attributable to our receipt of development milestone payments totaling $50.0 million in 2005 and 2006, which we are recognizing as revenue over the development period, which we estimate will be completed by June 2007. Our historical losses have resulted principally from costs 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. Under our collaboration agreement with Takeda, Takeda reimbursed us for the first $30.0 million in research and development expenses we incurred related to AMITIZA for the treatment of chronic idiopathic constipation and irritable bowel syndrome with constipation, and we are responsible for the next $20.0 million. Takeda’s reimbursement obligation covered substantially all of our research and development expenses for AMITIZA through 2005, by which time Takeda had satisfied its full $30.0 million reimbursement obligation. Accordingly, the unreimbursed portion of our research and development expenses increased significantly in 2006 and the first quarter of 2007. Whether we are able to achieve 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. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. If we are unable to achieve and maintain profitability, the market value of our class A common stock will decline and you could lose all or a part of your investment.
 
If we are unable to successfully commercialize our first product, AMITIZA, for the treatment of chronic idiopathic constipation in adults or other indications for which we are developing this drug, including irritable bowel syndrome with constipation, 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 generate product-based revenues will depend on the successful commercialization and continued development of AMITIZA. We recorded our first product royalty revenue from AMITIZA in the quarter ended June 30, 2006. The commercial success of AMITIZA will depend on several factors, including the following:
 
  •  the effectiveness of Takeda’s sales force, as supplemented by our internal specialty sales force, in marketing and selling AMITIZA in the United States for the treatment of chronic idiopathic constipation in adults;


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  •  the ability of R-Tech, which has the exclusive right to manufacture and supply AMITIZA, or any substitute manufacturer to supply quantities sufficient to meet market demand and at acceptable levels of quality and price;
 
  •  acceptance of the product within the medical community and by third-party payors;
 
  •  successful completion of clinical trials of AMITIZA for the treatment of other constipation-related gastrointestinal indications beyond chronic idiopathic constipation and irritable bowel syndrome with constipation, and acceptance of the results of these trials by regulatory authorities; and
 
  •  receipt of marketing approvals from the FDA and similar foreign regulatory authorities for the treatment of other indications, including marketing approval in the United States for AMITIZA to treat irritable bowel syndrome with constipation.
 
If we are not successful in commercializing AMITIZA for the treatment of chronic idiopathic constipation or other indications, 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 making the transition from a pre-commercial stage company to a commercial company, our ability to become profitable will be compromised.
 
For most of our operating history, we have been a pre-commercial stage company. We are in the process of transitioning to a company capable of supporting commercial activities, and we may not be successful in accomplishing this transition. 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 for the treatment of chronic idiopathic constipation in adults. 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 become 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, particularly in light of the recent resignation of our president and chair of our board of directors.
 
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 Ronald Kaiser, our chief financial officer, Mariam Morris, our chief accounting officer, Brad Fackler, our executive vice president of commercial operations, Gayle Dolecek, our senior vice president of research and development, Kei Tolliver, our vice president of business development and company operations, and Charles Hrushka, our vice president of marketing. 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.


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Dr. Sachiko Kuno, who had been serving as our president and chair of our board of directors, resigned as an executive officer and director of our company effective May 31, 2007. Although we expect that Dr. Kuno will continue to work for our company as a part-time employee, many of her duties will need to be assumed by our existing senior executives until we are able to identify and hire one or more additional senior executives to take her place. This could distract our senior management from their existing responsibilities and compromise our ability to effectively manage our company.
 
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 expect to expand our development, regulatory, sales and marketing, and finance and accounting capabilities, and as a result, we may encounter difficulties in managing our growth, which could disrupt our operations.
 
We expect to experience significant growth in the number of our employees and the scope of our operations, particularly in the areas of drug development, regulatory affairs, sales and marketing and finance and accounting. To manage our anticipated future growth, 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. Due to our limited resources, we may not be able to effectively manage the expansion of our operations or recruit and train additional qualified personnel. The expansion of our operations may lead to significant costs and may 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.
 
We previously identified material weaknesses in our internal control over financial reporting and those of Sucampo Europe and Sucampo Japan. If we fail to achieve and maintain effective internal control over financial reporting, we could face difficulties in preparing timely and accurate financial reports, which could lead to delisting of our class A common stock from The NASDAQ Global Market, to which we have applied to have our class A common stock approved for quotation, result in a loss of investor confidence in our reported results and cause the price of our class A common stock to fall.
 
In connection with the acquisition of Sucampo Europe and Sucampo Japan and our preparation of audited financial information for those two entities for the year ended December 31, 2005, we identified control deficiencies related to those entities that constitute material weaknesses in the design and operation of our internal controls over financial reporting.
 
In general, a material weakness is defined as a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of annual or interim financial statements will not be prevented or detected. The material weaknesses we identified are as follows:
 
  •  We did not maintain effective controls over the completeness and accuracy of revenue recognition. Specifically, effective controls were not designed and in place to adequately review contracts for the accuracy and proper cut-off of revenue recognition at Sucampo Europe and Sucampo Japan. This control deficiency resulted in adjustments to the revenue and deferred revenue accounts. Additionally, this control deficiency could result in a misstatement of the revenue and deferred revenue accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.


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  •  We did not maintain effective controls over the completeness and accuracy of the accounting for debt instruments. Specifically, effective controls were not designed and in place to adequately review debt agreements of Sucampo Europe and Sucampo Japan for the proper accounting implications, or to ensure appropriate communication within our company regarding the existence of all debt agreements. This control deficiency resulted in adjustments to accounts payable, other liabilities and notes payable accounts. Additionally, this control deficiency could result in a misstatement of accounts payable, other liabilities and notes payable accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
  •  We did not maintain effective controls over the preparation, review and presentation of the financial information prepared in accordance with U.S. generally accepted accounting principles reflecting Sucampo Europe and Sucampo Japan’s operations. Specifically, effective controls were not designed and in place to adequately review, analyze and monitor these affiliates’ financial information, nor did we have a standard reporting format for these affiliates, accounting procedures and policies manuals, formally documented controls and procedures or a formal process to review and analyze financial information of these affiliates. This control deficiency resulted in adjustments to revenue, deferred revenue, accounts payable, other liabilities and notes payable accounts, as well as the statement of cash flows. Additionally, this control deficiency could result in a misstatement in a number of our financial statement accounts, including the statement of cash flows, resulting in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
In connection with the restatement of our consolidated financial statements as of and for the year ended December 31, 2005 for errors in our deferred tax assets and our accounting for fully vested non-employee options granted, we identified additional control deficiencies that constitute material weaknesses in the design and operation of our internal controls over financial reporting. In particular:
 
  •  We did not maintain effective controls over the completeness, accuracy and valuation of accounting for certain income tax balances. Specifically, effective controls were not designed and in place to periodically assess, at an appropriate level of detail, the “more likely than not” criteria for recognition of deferred tax assets. This control deficiency resulted in adjustments to the deferred tax asset valuation allowance and the income tax provision accounts, which resulted in a restatement of our consolidated financial statements as of and for the year ended December 31, 2005. Additionally, this control deficiency could result in a misstatement of the deferred tax asset valuation allowance and income tax provision accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
  •  We did not maintain effective controls over the valuation and accuracy of accounting for non-employee stock options. Specifically, effective controls were not designed and in place to value the options using the contractual term as opposed to an expected term. This control deficiency resulted in adjustments to the research and development expenses and additional paid-in capital accounts and resulted in a restatement of our financial statements as of and for the year ended December 31, 2005. Additionally, this control deficiency could result in a misstatement of operating expenses and additional paid-in capital accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
The remediation of one of these material weaknesses is ongoing as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We cannot assure you that we will be able to remediate this weakness.
 
If we are unable to remediate our remaining material weakness, 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 of 1934, or the Exchange Act, upon the completion of this offering will intensify the need for us to report our financial position, results of operations and cash flows on an accurate and timely basis. We may not be able to prepare complete and accurate financial statements on a timely basis, which could result in delays in our public filings and ultimately


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delisting of our class A common stock from its principal trading market, which will be The NASDAQ Global Market if our application to have our class A common stock approved for quotation is approved.
 
The requirements of being a public company may strain our resources and distract management.
 
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 will be subject to the requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, The NASDAQ Global Market, to which we have applied to have our class A common stock approved for quotation, 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. 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 will need to hire additional accounting staff with appropriate public company experience and technical accounting knowledge and we cannot assure you that we will be able to do so in a timely fashion.
 
These rules and regulations 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 are currently evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
 
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, SPI-8811 and SPI-017, 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. Kuno and Ueno 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 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.
 
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 primarily responsible for making these decisions on our behalf. Dr. Ueno and his wife, Dr. Kuno, indirectly own all the stock of Sucampo AG. 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


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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:
 
  •  regulators or institutional review boards may not authorize us to commence a clinical trial or conduct a clinical trial at a prospective trial site;
 
  •  our preclinical tests or clinical trials may produce negative or inconclusive results, and as a result we may decide, or regulators may require us, to conduct additional preclinical testing or clinical trials or we may abandon projects that we consider to be promising. For example, the efficacy results in two of our Phase II trials of SPI-8811, specifically the trials for the treatment of non-alcoholic fatty liver disease and for the treatment of symptoms associated with cystic fibrosis, were inconclusive. Therefore, further clinical testing will be required in connection with the development of this compound for these indications;
 
  •  design of or enrollment in our clinical trials may be slower than we currently anticipate, resulting in significant delays, or participants may drop out of our clinical trials at rates that are higher than we currently anticipate;
 
  •  we might have to suspend or terminate our clinical trials, or perform additional trials, if we discover that the participating patients are being exposed to unacceptable health risks;
 
  •  regulators or institutional review boards may require that we hold, suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements;
 
  •  the cost of our clinical trials may be greater than we currently anticipate;
 
  •  we might have difficulty obtaining sufficient quantities of the product candidate being tested to complete our clinical trials;
 
  •  any regulatory approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render the product not commercially viable; and
 
  •  the effects of our product candidates may not be the desired or anticipated effects or may include undesirable side effects, or the product candidates may have other unexpected characteristics. For example, in preclinical tests of AMITIZA, the drug demonstrated a potential to cause fetal loss in guinea pigs and, as a result, its label includes cautionary language as to its use by pregnant women.


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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:
 
  •  be delayed in obtaining marketing approval for our product candidates;
 
  •  not be able to obtain marketing approval; or
 
  •  obtain approval for indications that are not as broad as those for which we apply.
 
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, or EMEA, 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 for chronic idiopathic constipation in adults 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 very 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 develop a sales and marketing organization or outsource these functions to third parties. There are risks associated with either of these alternatives. For example, developing a sales force is 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 will broadly market AMITIZA for the treatment of chronic idiopathic constipation in adults and for other constipation-related gastrointestinal indications, if approved, to office-based specialty physicians and primary care physicians in the United States. The Takeda sales force dedicated to selling AMITIZA will be significantly larger than our contract sales force, and we will therefore be heavily dependent on the marketing and sales efforts of Takeda.


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If our contract specialty 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.
 
Prior to July 1, 2007, we utilized Ventiv Commercial Services, LLC, or Ventiv, to provide us with a contract specialty sales force to market AMITIZA to hospital-based specialist physicians and long-term care facilities. We terminated our agreement with Ventiv effective July 1, 2007 and we are in the process of internalizing a significant portion of their sales staff as employees of our company. This internalization effort may not succeed and our ability to generate revenues and profits may be adversely affected.
 
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, Zelnorm®, which is marketed by Novartis Pharmaceuticals Corporation, has been approved both for the treatment of chronic idiopathic constipation in adults under 65 years of age and for the short-term treatment of irritable bowel syndrome with constipation in women. In March 2007, Zelnorm was withdrawn from the U.S. market by Novartis at the request of the FDA, but continues to be sold in other countries and may be acquired for use by individuals in the United States and in other markets. Zelnorm may be re-introduced to the U.S. and other markets at a later date and the FDA has indicated that it may allow Zelnorm to be prescribed to some patients under a special program in the meantime. In addition, the osmotic laxatives MiraLaxtm (polyethylene glycol 3350), 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:
 
  •  Drugs targeting serotonin receptors for the treatment of irritable bowel syndrome with constipation, such as Renzapride, being developed by Alizyme plc and currently in Phase III clinical trials, and DDP733, being developed by Dynogen Pharmaceuticals, Inc. and currently in Phase II clinical trials;
 
  •  Opioid antagonists such as methylnaltrexone, being developed by Progenics Pharmaceuticals, Inc., for the treatment of opioid-induced bowel dysfunction. Progenics and its partner Wyeth Pharmaceuticals recently filed an NDA with the FDA for a subcutaneous formulation of this drug for the treatment of opioid-induced bowel dysfunction in patients receiving palliative care; and
 
  •  TD-5108, being developed by Theravance, Inc. for the treatment of chronic constipation, and linaclotide, being developed by Microbia, Inc. for the treatment of irritable bowel syndrome with constipation, both of which have recently completed phase II clinical trials.


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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 SPI-8811 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 prevalence and severity of any side effects. For example, the most common side effects reported by participants in our clinical trials of AMITIZA for the treatment of chronic idiopathic constipation were nausea, which was reported by 31% of trial participants, and diarrhea and headache, both of which were reported by 13% of trial participants;
 
  •  the efficacy and potential advantages over alternative treatments;
 
  •  the competitiveness of the pricing of our products;
 
  •  the relative convenience and ease of administration of our products compared with other alternatives;
 
  •  the timing of the release of our products to the public compared to alternative products or treatments;
 
  •  the willingness of the target patient population to try new therapies and of physicians to prescribe these therapies;
 
  •  the strength of marketing and distribution support; and
 
  •  the level of third-party coverage or reimbursement.
 
The recent 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 recently identified 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 III clinical trial of Entereg to treat this condition, which had previously been filed with the FDA. This decision was reportedly based upon preliminary Phase III 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.


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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:
 
  •  a covered benefit under its health plan;
 
  •  safe, effective and medically necessary;
 
  •  appropriate for the specific patient;
 
  •  cost effective; and
 
  •  neither experimental nor investigational.
 
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. 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.


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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:
 
  •  decreased demand for AMITIZA or any other product that we may develop;
 
  •  injury to our reputation;
 
  •  withdrawal of clinical trial participants;
 
  •  costs to defend the related litigation;
 
  •  substantial monetary awards to trial participants or patients;
 
  •  loss of revenue; and
 
  •  the inability to continue to commercialize AMITIZA or to commercialize any other product that we may develop.
 
We currently have product liability insurance that covers our clinical trials in adult patients and our commercial sales of AMITIZA up to an annual aggregate limit of $20.0 million and that covers our clinical trials of AMITIZA in pediatric patients up to an annual aggregate limit of $5.0 million, in each case subject to a per claim deductible. 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.


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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 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 the net proceeds from this offering, together with 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:
 
  •  actual levels of AMITIZA product sales;
 
  •  the cost of commercialization activities, including product marketing, sales and distribution;
 
  •  the scope and results of our research, preclinical and clinical development activities;
 
  •  the timing of, and the costs involved in, obtaining regulatory approvals;
 
  •  the costs involved in obtaining and maintaining proprietary protection for our products, technology and know-how, including litigation costs and the results of such litigation;
 
  •  our ability to recruit and retain internal staff resources to conduct these activities;
 
  •  the extent to which we acquire or invest in businesses, products and technologies;
 
  •  the success of our collaboration with Takeda; and
 
  •  our ability to establish and maintain additional collaborations.
 
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, you may experience dilution. The holders of any new equity securities we issue may have rights, preferences or privileges that are senior to yours. 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.


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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, SPI-8811 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 in the Americas, Europe, the Middle East and Africa until 2026, and we do not have an alternative source of supply for AMITIZA in these or any other territories. We also do not have an alternative source of supply for SPI-8811 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. In addition, we currently do not have a manufacture or supply arrangement for the supply of AMITIZA in Asia. Our ability to market and sell AMITIZA in Asia also would be significantly impaired if we are unable to enter into a supply and manufacture arrangement with R-Tech or another suitable manufacturer for the supply of AMITIZA in that territory.
 
The risks of relying solely on R-Tech for the manufacture of our products include:
 
  •  we rely solely on R-Tech for quality assurance and their continued compliance with regulations relating to the manufacture of pharmaceuticals;
 
  •  R-Tech’s manufacturing capacity may not be sufficient to produce commercial quantities of our product, or to keep up with subsequent increases in the quantities necessary to meet potentially growing demand;
 
  •  R-Tech may not have access to the capital necessary to expand its manufacturing facilities in response to our needs;
 
  •  in light of the complexity of the manufacturing process for prostones, if R-Tech were to cease conducting business, or if its operations were to be interrupted, it would be difficult and time consuming for us to find a replacement supplier and the change would need to be submitted to and approved by the FDA;
 
  •  R-Tech has substantial proprietary know-how relating to the manufacture of prostones and, in the event we must find a replacement or supplemental manufacturer or we elect to contract with another manufacturer to supply us with products other than AMITIZA, we would need to transfer this know-how to the new manufacturer, a process that could be both time consuming and expensive to complete;
 
  •  R-Tech may experience events, such as a fire or natural disaster, that force it to stop or curtail production for an extended period; and
 
  •  R-Tech could encounter significant increases in labor, capital or other costs that would make it difficult for R-Tech to produce our products cost-effectively.
 
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


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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 current good manufacturing practice, or 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 collaboration with Takeda, 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.
 
Our agreement with Takeda provides that it may be terminated by either party if we fail to receive marketing approval from the FDA for AMITIZA for the treatment of irritable bowel syndrome with constipation and if we and Takeda do not thereafter agree on an alternative development and commercialization strategy. If Takeda were to terminate the agreement under these conditions, we would likely realize significantly lower revenues from sales of AMITIZA for the treatment of chronic idiopathic constipation until we could find a replacement marketing organization or develop our own, and our ability to continue our development program for AMITIZA for other gastrointestinal indications could be seriously compromised. In


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addition, if we fail to receive marketing approval from the FDA for this indication, we might not receive up to $30.0 million of development milestone payments that Takeda is obligated to pay us upon our achievement of future regulatory milestones relating to AMITIZA. We also might not receive up to $50.0 million of commercial milestone payments that Takeda is obligated to pay us upon the achievement of specified targets for annual net sales revenue from AMITIZA in the United States and Canada.
 
The success of our collaboration arrangement will depend heavily on the efforts and activities of Takeda. The risks that we face in connection with this collaboration, and that we anticipate being subject to in any future collaborations, include the following:
 
  •  our joint collaboration agreement with Takeda is, and any future collaboration agreements that we may enter into are likely to be, subject to termination under various circumstances;
 
  •  Takeda and other future collaborators may develop and commercialize, either alone or with others, products and services that are similar to or competitive with the products that are the subject of the collaboration with us;
 
  •  Takeda and other future collaborators may underfund or not commit sufficient resources to the testing, marketing, distribution or other development of our products or may use committed resources inefficiently;
 
  •  Takeda and other future collaborators may not properly maintain or defend our intellectual property rights or may utilize our proprietary information in such a way as to invite litigation that could jeopardize or invalidate our proprietary information or expose us to potential liability; and
 
  •  Takeda and other future collaborators may change the focus of their development and commercialization efforts. Pharmaceutical and biotechnology companies historically have re-evaluated their priorities from time to time, including following mergers and consolidations, which have been common in recent years in these industries.
 
The ability of our products and product candidates to reach their potential could be limited if Takeda or any other future collaborators decrease or fail to increase spending relating to such products, fail to dedicate sufficient resources to 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 Ventiv’s employees to market AMITIZA. Although we terminated our agreement with Ventiv effective July 1, 2007, any misconduct or inappropriate activities by Ventiv 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.


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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 us and Sucampo AG or R-Tech, 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. Dr. Kuno and Dr. 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, 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:
 
  •  disputes over the cost or quality of the manufacturing services provided to us by R-Tech with respect to AMITIZA, SPI-8811 and SPI-017;
 
  •  a decision whether to engage R-Tech in the future to manufacture and supply compounds other than AMITIZA, SPI-8811 and SPI-017;
 
  •  decisions as to which particular prostone compounds, other than AMITIZA, SPI-8811 or SPI-017, we will commit sufficient development efforts to so that commercial rights to those compounds will not revert back to Sucampo AG at the end of the specified period; or
 
  •  business opportunities unrelated to prostones that may be attractive both to us and to the other company.
 
If United States or foreign tax authorities disagree with our transfer pricing policies, 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. Kuno and Ueno. 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


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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.
 
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 our 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.


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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


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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:
 
  •  restrictions on such products, manufacturers or manufacturing processes;
 
  •  warning letters;
 
  •  withdrawal of the products from the market;
 
  •  refusal to approve pending applications or supplements to approved applications that we submit; and
 
  •  voluntary or mandatory product recalls.
 
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


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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 SPI-8811 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 SPI-8811 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 SPI-8811 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:
 
  •  the federal Medicare and Medicaid Anti-Kickback law, which prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid Programs;
 
  •  other Medicare laws, regulations, rules, manual provisions and policies that prescribe the requirements for coverage and payment for services performed by our customers, including the amount of such payment;
 
  •  the federal False Claims Act, which imposes civil and criminal liability on individuals and entities who submit, or cause to be submitted, false or fraudulent claims for payment to the government;


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  •  the federal False Statements Act, which prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false statement in connection with the delivery of or payment for healthcare benefits, items or services; and
 
  •  state and foreign law equivalents of the foregoing and state laws regarding pharmaceutical company marketing compliance, reporting and disclosure obligations.
 
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 the Offering
 
After this offering, our founders will 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.
 
When this offering is completed, after giving effect to the assumed issuance of 407,496 shares of class A common stock in connection with the founders make-whole awards, Dr. Sachiko Kuno, who was until recently an executive officer and director of our company, and Dr. Ryuji Ueno, our chief executive officer, chief scientific officer and a director, will together beneficially own 2,432,748 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. Kuno and Ueno, who are married, acting by themselves will be 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:
 
  •  the high-vote nature of our class B common stock;
 
  •  following the conversion of all shares of class B common stock into class A common stock, only one of our three classes of directors will be elected each year;


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  •  following the conversion of all shares of class B common stock into class A common stock, stockholders will not be entitled to remove directors other than by a 75% vote and for cause;
 
  •  following the conversion of all shares of class B common stock into class A common stock, stockholders will not be permitted to take actions by written consent;
 
  •  stockholders cannot call a special meeting of stockholders; and
 
  •  stockholders must give advance notice to nominate directors or submit proposals for consideration at stockholder meetings.
 
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.
 
If you purchase shares of class A common stock in this offering, you will suffer immediate dilution of your investment.
 
We expect the initial public offering price of our class A common stock to be substantially higher than the net tangible book value per share of our class A common stock. Therefore, if you purchase shares of our class A common stock in this offering, you will pay a price per share that substantially exceeds our pro forma net tangible book value per share after this offering. To the extent outstanding options or warrants are exercised, you will incur further dilution. Based on an assumed initial public offering price of $15.00 per share, the midpoint of the range set forth on the cover of this prospectus, you will experience immediate dilution of $13.35 per share, representing the difference between our pro forma net tangible book value per share after giving effect to this offering and the initial public offering price. In addition, purchasers of class A common stock in this offering will have contributed approximately 45.9% of the aggregate price paid by all purchasers of our common stock but will own only approximately 7.5% of our common stock outstanding after this offering.
 
In addition, as of June 30, 2007, we had outstanding stock options to purchase an aggregate of 1,150,900 shares of class A common stock at a weighted average exercise price of $8.29 per share. To the extent these outstanding options are exercised, there will be further dilution to investors in this offering.
 
An active trading market for our class A common stock may not develop.
 
Prior to this offering, there has been no public market for our common stock. The initial public offering price for our class A common stock will be determined through negotiations with the underwriters and may bear no relationship to the price at which the class A common stock will trade upon completion of this offering. Although we have applied to have our class A common stock quoted on The NASDAQ Global Market, an active trading market for our shares may never develop or be sustained following this offering. If an active market for our class A common stock does not develop, it may be difficult to sell shares you purchase in this offering without depressing the market price for the shares or to sell your shares at all.
 
Because our stock price may be volatile, purchasers of our class A common stock could incur substantial losses.
 
Our stock price is likely to be volatile. 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 initial public offering price. The market price for our class A common stock may be influenced by many factors, including:
 
  •  failure of AMITIZA or other approved products, if any, to achieve commercial success;
 
  •  results of clinical trials of our product candidates or those of our competitors;
 
  •  the regulatory status of our product candidates;


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  •  the success of competitive products or technologies;
 
  •  regulatory developments in the United States and foreign countries;
 
  •  developments or disputes concerning patents or other proprietary rights;
 
  •  the ability of R-Tech to manufacture our products to commercial standards in sufficient quantities;
 
  •  actual or anticipated fluctuations in our quarterly financial results;
 
  •  variations in the financial results of companies that are perceived to be similar to us;
 
  •  changes in the structure of healthcare payment systems;
 
  •  market conditions in the pharmaceutical and biotechnology sectors and issuance of new or changed securities analysts’ reports or recommendations; and
 
  •  general economic, industry and market conditions.
 
We have broad discretion in the use of the net proceeds from this offering and may not use them effectively.
 
Our management will have broad discretion in the application of the net proceeds from this offering and could spend the proceeds in ways that do not improve our results of operations or enhance the value of our class A common stock. The failure by our management to apply these funds effectively could result in financial losses, cause the price of our class A common stock to decline and delay the development of our product candidates. Pending their use, we may invest the net proceeds from this offering in a manner that does not produce income or that loses value.
 
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 in the near future. 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 following this offering, the market price of our class A common stock could decline significantly. Upon completion of this offering, after giving effect to the assumed issuance of 407,496 shares of class A common stock in connection with the founders make-whole awards, we will have outstanding 41,735,931 shares of common stock, assuming no exercise of outstanding options. Of these shares, the 3,750,000 shares sold in this offering will be freely tradable and 37,578,436 additional shares of common stock will be available for sale in the public market 180 days after the date of this prospectus following the expiration of lock-up agreements between our stockholders and the underwriters. The representatives of the underwriters may release these stockholders from their 180-day lock-up agreements with the underwriters at any time and without notice, which would allow for earlier sales of shares in the public market. Moreover, after this offering, holders of an aggregate of 6,751,609 shares of our common stock will 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 intend to register the 13,900,900 shares of class A common stock that we may issue in the future under our equity compensation plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to the 180-day lock-up agreements with our underwriters.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this prospectus regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans and objectives of management are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements include, among other things, statements about:
 
  •  our plans for selling and marketing AMITIZA in the United States for treatment of chronic idiopathic constipation in adults and our plans to seek regulatory approval to market AMITIZA in jurisdictions outside the United States;
 
  •  our plans to develop other indications for AMITIZA;
 
  •  our plans to develop SPI-8811 and SPI-017 and potentially other compounds;
 
  •  our collaborative arrangement with Takeda;
 
  •  our ongoing and planned research programs and clinical trials;
 
  •  the timing of and our ability to obtain and maintain regulatory approvals;
 
  •  the rate and degree of market acceptance and clinical utility of our products;
 
  •  our ability to quickly and efficiently develop clinical candidates;
 
  •  our marketing and manufacturing capabilities and strategy;
 
  •  our intellectual property portfolio;
 
  •  our estimates regarding expenses, future revenues, capital requirements and needs for additional financing; and
 
  •  our belief that the net proceeds from this offering, together with our existing cash and cash equivalents and internally generated funds from AMITIZA product sales, will be sufficient to enable us to fund our operating expenses for the foreseeable future.
 
We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in this prospectus, particularly in the “Risk Factors” section, that we believe could cause actual results or events to differ materially from the forward-looking statements that we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.
 
You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We do not assume any obligation to update any forward-looking statements.


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USE OF PROCEEDS
 
We estimate that the net proceeds from this offering will be approximately $38.6 million, assuming an initial public offering price of $15.00 per share, which is the midpoint of the price range listed on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and offering expenses payable by us. A $1.00 increase or decrease in the assumed initial public offering price of $15.00 per share would increase or decrease the net proceeds to us from this offering by $2.9 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We will not receive any of the proceeds from the sale of shares of our class A common stock in this offering by the selling stockholders.
 
We expect to use the net proceeds from this offering as follows:
 
  •  up to $1.0 million to fund our share of two post-marketing studies of AMITIZA to evaluate its safety in patients with renal impairment and patients with hepatic impairment;
 
  •  approximately $18.0 million to fund development and regulatory activities for SPI-8811 and SPI-017, which we expect will enable us to complete at least the following development efforts:
 
  •  a Phase II clinical trial of SPI-8811 for the prevention and treatment of NSAID-induced ulcers;
 
  •  a Phase II proof-of-concept study of SPI-8811 in patients with portal hypertension;
 
  •  a Phase II clinical trial of SPI-8811 in patients with cystic fibrosis; and
 
  •  Phase I clinical trials of an intravenous formulation of SPI-017 for peripheral arterial and vascular disease and stroke;
 
  •  up to $12.0 million to fund the expansion of our commercialization activities in the United States and the initiation of commercialization efforts in non-U.S. markets;
 
  •  up to $1.0 million to fund regulatory efforts by Sucampo Europe and Sucampo Japan for AMITIZA and SPI-8811;
 
  •  up to $6.0 million for research and development activities for prostone compounds other than AMITIZA, SPI-8811 and SPI-017;
 
  •  up to $1.0 million to fund costs in connection with computers, software and information technology to support growth in our business; and
 
  •  any balance to fund working capital, capital expenditures and other general corporate purposes, which may include the acquisition or in-license of complementary technologies, products or businesses.
 
This expected use of proceeds from this offering represents our intentions based upon our current plans and business conditions. The amounts and timing of our actual expenditures may vary significantly depending upon numerous factors, including the progress of our development and commercialization efforts, the progress of our clinical trials and our operating costs and capital expenditures. As a result, we will retain broad discretion in the allocation of the net proceeds from this offering. We have no current understandings, commitments or agreements to acquire or in-license any technologies, products or businesses.
 
Pending use of the proceeds from this offering, we intend to invest the proceeds in short-term, investment-grade, interest-bearing instruments.
 
DIVIDEND POLICY
 
We have never paid or declared any cash dividends on our common stock. We currently intend to retain all available funds and any future earnings to fund the growth and development of our business, and we do not anticipate paying any cash dividends in the foreseeable future.


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CAPITALIZATION
 
The following table sets forth our cash and cash equivalents, short-term investments and capitalization as of March 31, 2007:
 
  •  on an actual basis;
 
  •  on a pro forma basis to give effect to the automatic conversion of all outstanding shares of our preferred stock into an aggregate of 3,213,000 shares of class A common stock upon the closing of this offering and our issuance of 407,496 shares of class A common stock and our payment of $4.1 million in cash immediately following this offering in connection with the founders make-whole awards, assuming a public offering price of $15.00 per share; and
 
  •  on a pro forma as adjusted basis to give effect to the sale of 3,125,000 shares of class A common stock in this offering at an assumed initial public offering price of $15.00 per share, after deducting estimated underwriting discounts and commissions and offering expenses payable by us.
 
You should read this table together with our consolidated financial statements and the related notes appearing elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
                         
    As of March 31, 2007  
                Pro Forma
 
    Actual     Pro Forma     As Adjusted  
    (in thousands)  
 
Cash and cash equivalents
  $ 15,692     $ 11,617     $ 50,211  
Short-term investments
    29,399       29,399       29,399  
                         
Stockholders’ equity:
                       
Series A convertible preferred stock, $0.01 par value; 3,780 shares issued and outstanding, actual; no shares issued and outstanding, pro forma and pro forma as adjusted
  $ 20,288     $     $  
Class A common stock, $0.01 par value; 8,799,385 shares issued and outstanding, actual; 12,419,881 shares issued and outstanding, pro forma; and 15,544,881 shares issued and outstanding, pro forma as adjusted
    88       124       155  
Class B common stock, $0.01 par value; 26,191,050 shares outstanding, actual, pro forma and pro forma as adjusted
    262       262       262  
Additional paid-in capital
    41,400       67,764       106,327  
Accumulated other comprehensive loss
    (273 )     (273 )     (273 )
Accumulated deficit
    (22,850 )     (33,037 )     (33,037 )
                         
Total stockholders’ equity
    38,915       34,840       73,434  
                         
Total capitalization
  $ 38,915     $ 34,840     $ 73,434  
                         


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A $1.00 increase or decrease in the assumed initial public offering price of $15.00 per share of class A common stock would increase or decrease pro forma as adjusted cash and cash equivalents and short-term investments by $2.9 million, and increase or decrease pro forma as adjusted additional paid-in capital, total stockholders’ equity and total capitalization by a total of $2.9 million, assuming that the number of shares of class A common stock offered by us, as set forth on the cover page of this prospectus, remains the same. The information discussed in this paragraph is illustrative only and following the completion of this offering will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing.
 
The number of shares in the table above excludes:
 
  •  1,164,500 shares of our class A common stock issuable upon the exercise of stock options at a weighted average exercise price of $8.31 per share; and
 
  •  an aggregate of 12,750,000 shares of class A common stock reserved for future issuance under our equity compensation plans as of the completion of this offering.


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DILUTION
 
If you invest in our class A common stock, your interest will be diluted immediately to the extent of the difference between the public offering price per share of our class A common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering.
 
Our net tangible book value as of March 31, 2007 was $34.4 million, or $0.98 per share of common stock. Net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of our common stock outstanding. On a pro forma basis, after giving effect to the automatic conversion of all outstanding shares of our convertible preferred stock into an aggregate of 3,213,000 shares of class A common stock upon the closing of this offering and our issuance of 407,496 shares of class A common stock and our payment of $4.1 million in cash immediately following this offering in connection with the founders make-whole awards, assuming a public offering price of $15.00 per share, our net tangible book value as of March 31, 2007 was $30.3 million, or $0.78 per share of common stock.
 
After giving effect to the issuance and sale of the 3,125,000 shares of class A common stock in this offering, at an assumed initial public offering price of $15.00 per share, less the estimated underwriting discounts and commissions and offering expenses payable by us, our pro forma as adjusted net tangible book value as of March 31, 2007 would have been $68.9 million, or $1.65 per share of class A and class B common stock. This represents an immediate increase in net tangible book value per share of $0.87 to existing stockholders and immediate dilution of $13.35 per share to new investors. Dilution per share to new investors is determined by subtracting pro forma as adjusted net tangible book value per share after this offering from the initial public offering price per share paid by a new investor. The following table illustrates the per share dilution without giving effect to the over-allotment option granted to the underwriters:
 
                 
Assumed initial public offering price per share of class A common stock
          $ 15.00  
                 
Actual net tangible book value per share as of March 31, 2007
  $ 0.98          
Decrease per share attributable to conversion of preferred stock and founders make-whole awards
    0.20          
                 
Pro forma net tangible book value per share as of March 31, 2007
    0.78          
Increase per share attributable to new investors
    0.87          
                 
Pro forma as adjusted net tangible book value per share after this offering
            1.65  
                 
Dilution per share to new investors
          $ 13.35  
                 
 
A $1.00 increase or decrease in the assumed initial public offering price of $15.00 per share of class A common stock would increase or decrease the pro forma as adjusted net tangible book value per share after this offering by $0.07 per share and the dilution per share to new investors in this offering by $0.93 per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.
 
If the underwriters exercise their over-allotment option in full, there would be no effect on our pro forma as adjusted net tangible book value or book value per share. If any shares are issued in connection with outstanding options, you will experience further dilution.


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The following table summarizes as of March 31, 2007, on the pro forma basis described above, the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by the existing stockholders and by new investors in this offering at an assumed initial public offering price of $15.00 per share, which is the midpoint of the price range listed on the cover page of this prospectus, before deducting estimated underwriting discounts and commissions and other expenses of this offering.
 
                                         
    Total Class A and Class B Shares     Total Consideration     Average Price
 
    Number     %     Amount     %     Per Share  
 
Existing stockholders
    38,610,931       92.5 %   $ 55,273,011       54.1 %   $ 1.43  
New investors
    3,125,000       7.5       46,875,000       45.9       15.00  
                                         
Total
    41,735,931       100.0 %   $ 102,148,011       100.0 %        
                                         
 
The sale by a selling stockholder of 625,000 shares of class A common stock in this offering will cause:
 
  •  the number of shares of common stock held by existing stockholders to be 37,985,931, or approximately 91.0% of the total number of shares of our common stock outstanding after this offering; and
 
  •  the number of shares held by new investors to be 3,750,000, or approximately 9.0% of the total number of shares of our common stock outstanding after this offering.
 
A $1.00 increase or decrease in the assumed initial public offering price of $15.00 per share of class A common stock would increase or decrease the total consideration paid by new investors by $3.1 million, and increase or decrease the percent of total consideration paid by new investors by 1.7 percentage points, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.
 
The table above is based on shares outstanding as of March 31, 2007 and excludes:
 
  •  1,164,500 shares of our class A common stock issuable at that date upon the exercise of stock options at a weighted average exercise price of $8.31 per share; and
 
  •  an aggregate of 12,750,000 shares of class A common stock reserved at that date for future issuance under our equity compensation plans as of the completion of this offering.
 
If the underwriters’ over-allotment option is exercised in full, the following will occur:
 
  •  the number of shares of common stock held by existing stockholders will decrease to 37,423,431, or approximately 89.7% of the total number of shares of our common stock outstanding after this offering; and
 
  •  the number of shares held by new investors will be increased to 4,312,500, or approximately 10.3%, of the total number of shares of our common stock outstanding after this offering.


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SELECTED CONSOLIDATED FINANCIAL DATA
 
You should read the following selected consolidated financial data in conjunction with our consolidated financial statements and the related notes appearing at the end of this prospectus and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus. In September 2006, we acquired all of the capital stock of Sucampo Europe and Sucampo Japan. Accordingly, we have presented our financial statements on a consolidated basis as a merger of entities under common control for all periods presented to reflect this transaction. The pro forma net income per share amounts and the number of shares used in computing pro forma per share amounts give effect to the conversion of our convertible preferred stock into class A common stock. We have derived the following consolidated financial data as of December 31, 2005 and 2006 and for the four years ended December 31, 2006 from consolidated financial statements audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm. Consolidated balance sheets as of December 31, 2005 and 2006 and the related consolidated statements of operations, of changes in stockholders’ (deficit) equity and of cash flows for each of the three years in the period ended December 31, 2006 and notes thereto appear elsewhere in this prospectus. We have derived the following consolidated financial data as of December 31, 2002, 2003 and 2004 and for the year ended December 31, 2002 from unaudited consolidated financial statements, which are not included in this prospectus. We have derived the following consolidated financial data as of March 31, 2007 and for the three months ended March 31, 2006 and 2007 from unaudited consolidated financial statements, which appear elsewhere in this prospectus, which we have prepared on the same basis as the audited consolidated financial statements and which, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the unaudited interim periods. Interim financial results are not necessarily indicative of results to be expected for the full year or for any future reporting period. As discussed in note 2 to our consolidated financial statements, we have restated our consolidated financial statements for the years ended December 31, 2004 and 2005 and the three months ended March 31, 2006 to correct for revenue recognition errors.
 
                                                         
          Three Months
 
          Ended
 
    Year Ended December 31,     March 31,  
    2002     2003     2004     2005     2006     2006     2007  
                (Restated)     (Restated)           (Restated)        
    (in thousands, except per share data)  
 
Statement of operations data:
                                                       
Revenues
  $ 8,097     $ 4,125     $ 3,839     $ 40,205     $ 59,267     $ 24,168     $ 12,960  
Operating expenses:
                                                       
Research and development
    12,549       18,445       14,036       31,167       16,392       6,120       5,946  
General and administrative
    6,536       7,447       8,216       7,760       14,587       2,968       2,834  
Selling and marketing
                      295       11,103       948       3,231  
Milestone royalties — related parties
                1,000       1,500       1,250       1,250        
Product royalties — related parties
                            1,172             410  
                                                         
Total operating expenses
    19,085       25,892       23,252       40,722       44,504       11,286       12,421  
                                                         
(Loss) income from operations
    (10,988 )     (21,767 )     (19,413 )     (517 )     14,763       12,882       539  
Total non-operating income (expense), net
    7,721       (250 )     (56 )     990       2,141       425       318  
                                                         
(Loss) income before income taxes
    (3,267 )     (22,017 )     (19,469 )     473       16,904       13,307       857  
Income tax (provision) benefit
    (681 )                 (789 )     4,897             (341 )
                                                         
Net (loss) income
  $ (3,948 )   $ (22,017 )   $ (19,469 )   $ (316 )   $ 21,801     $ 13,307     $ 516  
                                                         
Basic net (loss) income per share
  $ (0.12 )   $ (0.68 )   $ (0.60 )   $ (0.01 )   $ 0.63     $ 0.41     $ 0.01  
                                                         
Diluted net (loss) income per share
  $ (0.12 )   $ (0.68 )   $ (0.60 )   $ (0.01 )   $ 0.63     $ 0.40     $ 0.01  
                                                         
Weighted average common shares outstanding — basic
    31,681       32,564       32,600       32,601       34,383       32,605       34,990  
                                                         
Weighted average common shares outstanding — diluted
    31,681       32,564       32,600       32,601       34,690       33,133       35,429  
                                                         
Basic pro forma net income per share
                                                  $ 0.01  
                                                         
Diluted pro forma net income per share
                                                  $ 0.01  
                                                         
Pro forma weighted average common shares outstanding — basic
                                                    38,203  
                                                         
Pro forma weighted average common shares outstanding — diluted
                                                    38,642  
                                                         


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                                  As of
 
    As of December 31,     March 31,
 
    2002     2003     2004     2005     2006     2007  
                (Restated)     (Restated)              
    (in thousands)        
 
Balance sheet data:
                                               
Cash and cash equivalents
  $ 31,393     $ 19,070     $ 21,918     $ 17,436     $ 22,481     $ 15,692  
Short-term investments
                3,000       28,435       29,399       29,399  
Working capital
    27,850       14,834       7,850       10,051       40,623       40,483  
Total assets
    32,455       20,072       25,837       47,985       67,084       62,168  
Notes payable — related parties, current
    250       271       4,040       848              
Notes payable — related parties, net of current portion
    241       3,352       2,326       2,546              
Total liabilities
    4,463       14,196       39,375       58,225       28,551       23,253  
Accumulated deficit
    (3,366 )     (25,382 )     (44,852 )     (45,167 )     (23,366 )     (22,850 )
Total stockholders’ equity (deficit)
    27,992       5,876       (13,538 )     (10,240 )     38,533       38,915  


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information appearing at the end of this prospectus. Some of the information contained in this discussion and analysis or set forth elsewhere in this prospectus, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of this prospectus for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
 
Restatement of Previously Issued Consolidated Financial Statements
 
We have restated our previously issued consolidated financial statements and related footnotes as of December 31, 2005, for the years ended December 31, 2004 and 2005 and for the three months ended March 31, 2006. We have restated our consolidated financial statements to correct an error in accounting for the revenue recognition of our collaboration and license agreement and related agreements with Takeda Pharmaceutical Company Limited, or Takeda. All amounts in this discussion and analysis have been updated to reflect this restatement. For additional information regarding this restatement, see note 2 to our consolidated financial statements.
 
The error we are correcting in the restatement originated in the fourth quarter of 2004 and continued throughout 2005. The identification of this error occurred as a result of our reevaluation of the assumptions we used under Emerging Issues Task Force, or EITF, Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”, or EITF 00-21, in accounting for arrangements with multiple deliverables that require significant judgment and estimates.
 
We reassessed the stand-alone value to Takeda of the deliverables under our joint collaboration and license agreement with Takeda, at the time we became obliged to make such deliverables, by examining objective and reliable evidence of the fair value of the undelivered items. As a result of this reassessment, we determined that the previous application of a single unit of accounting for the deliverables from the joint collaboration and license agreement with Takeda was not appropriate. In addition, we determined that the substantive milestone method of revenue recognition we had been using was not appropriate to account for the cash payments received from Takeda related to our completion of these required deliverables and that a time-based model would be more appropriate to account for these cash payments. Accordingly, in the restated consolidated financial statements for the years ended December 31, 2004 and 2005, we reduced the milestone revenue and increased research and development revenue. Total revenue increased by $1.2 million for the year ended December 31, 2004 and decreased by $6.8 million for the year ended December 31, 2005. In addition, related deferred revenue increased by $5.6 million at December 31, 2005.
 
We will report the correct balances in our consolidated financial statements for the quarters ended June 30, 2006 and September 30, 2006 when we next file them. All data included in this discussion and analysis for the years ended December 31, 2004 and 2005 and for the three months ended March 31, 2006 are derived from our restated financial statements for those periods.
 
Overview
 
We are an emerging pharmaceutical 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. In January 2006, we received marketing approval from the FDA for our first product, AMITIZA, for the treatment of chronic idiopathic constipation in adults.
 
We are party to a collaboration and license agreement with Takeda to jointly develop and commercialize AMITIZA for chronic idiopathic constipation, irritable bowel syndrome with constipation, opioid-induced bowel dysfunction and other gastrointestinal indications in the United States and Canada. We have the right to


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co-promote AMITIZA along with Takeda in these markets. We and Takeda initiated commercial sales of AMITIZA in the United States for the treatment of chronic idiopathic constipation in adults in April 2006.
 
We and Takeda initiated commercial sales of AMITIZA for the treatment of chronic idiopathic constipation in adults in April 2006, and we first generated product royalty revenue in the quarter ended June 30, 2006. Since inception we have incurred operating losses and, as of March 31, 2007, we had an accumulated deficit of $22.9 million. Our net losses were $19.5 million in 2004 and $316,000 in 2005. We recognized net income of $21.8 million in 2006 and $516,000 for the three months ended March 31, 2007. The historical losses resulted principally from costs 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 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 as they are developed and augment our sales and marketing capabilities. Whether we are able to sustain profitability will depend upon our ability to generate revenues in the future that exceed these expenses. In the near term, our ability to generate product revenues will depend primarily on the successful commercialization and continued development of additional indications for AMITIZA.
 
We hold an exclusive worldwide royalty-bearing license from Sucampo AG to develop and commercialize AMITIZA and all other prostone compounds covered by patents and patent applications held by Sucampo AG. 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. If we have not committed specified development efforts to any prostone compound other than AMITIZA, SPI-8811 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. Kuno and Ueno 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.
 
In September 2006, we acquired all of the capital stock of two affiliated European and Asian operating companies, Sucampo Europe and Sucampo Japan, that were previously under common control with us. Sucampo Europe and Sucampo Japan are now wholly owned subsidiaries of our company. In this prospectus, we have presented financial statements that reflect our financial position, results of operations and cash flows on a consolidated basis with these two operating companies because the acquisition was consummated during the year ended December 31, 2006, and this management’s discussion and analysis of financial condition and results of operations discusses such consolidated financial statements.
 
Our Clinical Development Programs
 
We are developing AMITIZA and our other prostone compounds for the treatment of a broad range of diseases. The most advanced of these programs are:
 
  •  AMITIZA.  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, in patients with renal impairment and in patients with hepatic impairment. We initiated these studies in January 2007. In addition, we are developing AMITIZA to treat irritable bowel syndrome with constipation and opioid-induced bowel dysfunction. We recently completed two pivotal Phase III clinical trials of AMITIZA for the treatment of irritable bowel syndrome with constipation and a follow-on safety study to assess the long-term use of AMITIZA as a treatment for this indication. Based upon the results of these trials, we submitted a supplement to our existing new drug application, or NDA, for AMITIZA to the FDA in June 2007 seeking marketing approval for AMITIZA for the treatment of this indication. In addition, we plan to commence Phase III pivotal clinical trials of AMITIZA for the treatment of opioid-induced bowel dysfunction in the third quarter of 2007. Our collaboration and co-promotion arrangement with Takeda also covers these additional indications for AMITIZA.
 
  •  SPI-8811(cobiprostone).  We are developing orally administered SPI-8811 to treat various gastrointestinal and liver disorders, including NSAID-induced ulcers, portal hypertension, non-alcoholic fatty liver


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  disease and gastrointestinal disorders associated with cystic fibrosis. We also are planning to develop an inhaled formulation of SPI-8811 for the treatment of respiratory symptoms of cystic fibrosis and chronic obstructive pulmonary disease. Our near term focus is on the development of SPI-8811 as a treatment for NSAID-induced ulcers. We have completed Phase I clinical trials of SPI-8811 in healthy volunteers and plan to commence a Phase II clinical trial of this product candidate for the treatment of NSAID-induced ulcers in the third quarter of 2007. We also plan to commence a Phase II proof-of-concept study of SPI-8811 in patients with portal hypertension in 2007.
 
  •  SPI-017.  We are developing SPI-017 to treat vascular disease and central nervous system disorders. We are initially focused on developing an intravenous formulation of this product candidate for the treatment of peripheral arterial disease. We also are developing an oral formulation of SPI-017 for the treatment of Alzheimer’s disease. We plan to commence Phase I clinical trials of the intravenous formulation of SPI-017 and Phase I clinical trials of the oral formulation in 2008.
 
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 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 are recognizing 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 we estimate will be completed by 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 also received the following non-refundable payments from Takeda reflecting our achievement of specific product development milestones:
 
  •  $10.0 million upon the filing of the NDA for AMITIZA to treat chronic idiopathic constipation in March 2005;
 
  •  $20.0 million upon the initiation of our Phase III clinical trial related to AMITIZA for the treatment of irritable bowel syndrome with constipation in May 2005; and
 
  •  $20.0 million upon the receipt of approval from the FDA for AMITIZA for the treatment of chronic idiopathic constipation in adults in January 2006.
 
We are recognizing each of these payments 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 we estimated would be completed by June 2007.
 
In June 2007, we submitted a supplement to our existing NDA for AMITIZA to the FDA seeking marketing approval for AMITIZA for the treatment of irritable bowel syndrome with constipation. As a result of this submission, Takeda is required by the terms of our collaboration agreement with them to make a $30.0 million milestone payment to us. We expect to recognize the entire amount of this payment as research and development revenue in the quarter ended June 30, 2007, reflecting the end of the development period for AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation.


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In addition, our collaboration agreement requires that Takeda pay us up to a further aggregate of $60.0 million conditioned upon our achievement of future regulatory milestones relating to AMITIZA. We would recognize these payments as research and development revenue ratably over the respective performance periods.
 
Research and Development Cost-Sharing for AMITIZA
 
Our collaboration agreement with Takeda provides for the sharing between Takeda and us of the costs of our research and development activities for AMITIZA in the United States and Canada as follows:
 
  •  Takeda was responsible for the first $30.0 million in research and development expenses we incurred after October 2004 related to AMITIZA for the treatment of chronic idiopathic constipation and irritable bowel syndrome with constipation. We received reimbursement payments from Takeda of $1.5 million in 2004 and $28.5 million in 2005. We are recognizing each of these payments 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 we estimate will be completed by June 2007, with the exception that we do not recognize revenue in any period to the extent that it resulted in cumulative recognized revenue exceeding cumulative reimbursable expenses incurred.
 
We are responsible for the next $20.0 million in research and development expenses we incur related to AMITIZA for the treatment of chronic idiopathic constipation and irritable bowel syndrome with constipation. Thereafter, any expenses in excess of $50.0 million are shared equally between Takeda and us. Because we have received reimbursements of $30.0 million from Takeda, we are now responsible for the next $20.0 million of these expenses. Of this next $20.0 million, we had incurred $11.0 million through March 31, 2007. We do not expect aggregate expenses necessary to complete development of AMITIZA for these two indications will exceed the $20.0 million for which we are solely responsible.
 
  •  For research and development expenses relating to changing or expanding the labeling of AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation, Takeda is responsible for 70% of these expenses and we are responsible for 30%. We have not incurred any expenses of this nature to date. However, 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 patients with renal impairment and patients with hepatic impairment. We initiated these studies in January 2007. The expenses of these studies, which we began to incur in the quarter ended September 30, 2006, are being shared 70% by Takeda and 30% by us. Through March 31, 2007, we had incurred $803,000 of these expenses, of which we will be reimbursed $562,000.
 
  •  The expense of Phase IV clinical trials of AMITIZA for the treatment of chronic idiopathic constipation in pediatric patients that we initiated in January 2007 will be borne by Takeda in full. As of March 31, 2007, we had incurred $2.4 million of these expenses, all of which will be reimbursed by Takeda.
 
  •  For expenses in connection with additional clinical trials required by regulatory authorities relating to AMITIZA to treat chronic idiopathic constipation or irritable bowel syndrome with constipation, Takeda and we are responsible to share these expenses equally. We have not incurred any expenses of this nature to date.
 
  •  Takeda is responsible for the first $50.0 million in expenses we incur related to the development of AMITIZA for each gastrointestinal indication other than chronic idiopathic constipation and irritable bowel syndrome with constipation, and any expenses in excess of $50.0 million are shared equally between Takeda and us. We plan to initiate clinical trials of AMITIZA for the treatment of opioid-induced bowel dysfunction in the third quarter of 2007. We began incurring expenses for these trials in the third quarter of 2006. Currently, we do not anticipate the aggregate expenses necessary to complete


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  our development of AMITIZA for this indication will exceed $54.0 million, of which Takeda will be responsible for $52.0 million and we will be responsible for $2.0 million. As of March 31, 2007, we had incurred $1.5 million of these expenses.
 
  •  Takeda is responsible for the first $20.0 million in expenses we incur related to the development of each new formulation of AMITIZA, and any expenses in excess of $20.0 million are shared equally between Takeda and us. We have not incurred any expenses of this nature to date.
 
Co-Promotion Expense Reimbursements
 
In connection with our exercise of our co-promotion rights under the collaboration agreement and our entry into the related supplemental agreement in February 2006, Takeda agreed to reimburse us for a portion of our expenses related to our specialty sales force. We estimate that these reimbursements will cover approximately 80% of the direct costs for our current sales force of 38 sales representatives. We began to receive monthly reimbursement for these expenses during the quarter ended June 30, 2006, reflecting the commencement by our sales representatives of their activities in April 2006, and we had recognized $3.4 million of co-promotion revenue reflecting these reimbursements through December 31, 2006. In the quarter ended March 31, 2007, we recognized $974,000 of co-promotion revenue reflecting these reimbursements.
 
Takeda also agreed in the supplemental agreement 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 year ended December 31, 2006, we recognized $779,000 of co-promotion revenue reflecting these reimbursements and during the quarter ended March 31, 2007, we recognized $158,000. We completed the miscellaneous marketing activities to which these reimbursements relate in the quarter ended March 31, 2007 and, accordingly, we do not expect to recognize additional co-promotion revenue related to these activities.
 
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 will depend on the level of net sales revenue during 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. We began to recognize product royalty revenue in the quarter ended June 30, 2006, reflecting the commencement of commercial sales of AMITIZA in April 2006. During the year ended December 31, 2006, we recognized a total of $6.6 million as product royalty revenue under our collaboration agreement with Takeda and during the quarter ended March 31, 2007, we recognized $2.3 million 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 March 31, 2007.
 
Option Payment
 
In November 2004, we received $5.0 million from Takeda as an option payment to continue negotiations for the joint development and commercialization of AMITIZA for gastrointestinal indications in additional territories. In the event that these negotiations failed to produce a definitive agreement by specified dates, the terms of the option required us to repay $2.5 million of the original $5.0 million option payment to Takeda. As to the $2.0 million of the option payment relating to joint development and commercialization in Asia, we recorded $1.0 million as current deferred revenue and $1.0 million as other short-term liabilities in 2004. As to the $3.0 million of the option payment relating to Europe, the Middle East and Africa, we recorded $1.5 million as long term deferred revenue and $1.5 million as other long-term liabilities in 2004. The option right for Asia expired during 2005, at which time we repaid $1.0 million to Takeda and recognized the remaining $1.0 million as contract revenue. The option right for Europe, the Middle East and Africa expired


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during the first quarter of 2006, at which time we repaid $1.5 million to Takeda and recognized the remaining $1.5 million as contract revenue.
 
Takeda Cash Flows and Revenue
 
The following table summarizes the cash streams and related revenue recognition under the Takeda collaboration agreement and the related supplemental agreement for the periods indicated:
 
                                                                 
    Cash Received
                      Amount
    Cash Received
    Revenue Recognized
    Amount
 
    Through
                      Deferred at
    For the Three
    For the Three
    Deferred at
 
    December 31,
    Revenue Recognized for Year Ended December 31,     December 31,
    Months Ended
    Months Ended
    March 31,
 
    2006     2004     2005     2006     2006     March 31, 2007     March 31, 2007     2007  
    (in thousands)  
 
Collaboration revenue:
                                                               
Up-front payment attributable to the joint steering, manufacturing and commercialization committees
  $ 2,376     $ 24     $ 147     $ 147     $ 2,058     $     $ 37     $ 2,021  
                                                                 
Research and development revenue:
                                                               
Up-front payment — remainder
  $ 17,624     $ 1,356     $ 8,134     $ 6,157     $ 1,977     $     $ 1,087     $ 890  
Development milestones
    50,000             16,154       28,237       5,609             3,085       2,524  
Reimbursement of research and development expenses
    31,507       1,482       14,672       11,988       3,365       3,343       5,194       1,514  
                                                                 
Total
  $ 99,131     $ 2,838     $ 38,960     $ 46,382     $ 10,951     $ 3,343     $ 9,366     $ 4,928  
                                                                 
                                                                 
                                                                 
                                                                 
                            Accounts
                Accounts
 
                            Receivable at
                Receivable at
 
                            December 31,
                March 31,
 
                            2006                 2007  
 
Product royalty revenue
  $ 4,561                 $ 6,590     $ 2,029     $ 2,029     $ 2,309     $ 2,309  
                                                                 
Co-promotion revenue
  $ 3,535                 $ 4,243     $ 708     $ 1,567     $ 1,132     $ 273  
                                                                 
 
Financial Terms of our License from Sucampo AG
 
Under our license agreement with our affiliate, Sucampo AG, we are required to pay Sucampo AG 5% of every milestone payment we receive from a sublicensee, such as Takeda. We also are obligated to make the following milestone payments to Sucampo AG:
 
  •  $500,000 upon initiation of the first Phase II clinical trial for each compound in each of three territories covered by the license: North, Central and South America, including the Caribbean; Asia; and the rest of the world; and
 
  •  $1.0 million for the first NDA filing or comparable foreign regulatory filing for each compound in each of these three territories.
 
In addition, we are required to pay Sucampo AG, on a country-by-country basis, royalty payments of 6.5% of net sales for every product covered by existing patents and, if applicable, thereafter 4.25% of net sales for every product candidate covered by new or improvement patents assigned by us to Sucampo AG. With respect to sales of AMITIZA in North, Central and South America, including the Caribbean, the rates for these royalty payments are set at 3.2% and 2.1% of net sales, respectively. The product royalties that we pay to Sucampo AG are based on total product net sales, whether by us or a sublicensee, and not on amounts actually received by us. We expensed $1.2 million in product royalties to Sucampo AG during the year ended December 31, 2006 and $410,000 during the three months ended March 31, 2007, reflecting 3.2% of net sales for AMITIZA during each of these periods, which we recorded as product royalties to related parties on the consolidated statement of operations.


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We paid Sucampo AG $1.0 million, reflecting 5% of the $20.0 million up-front payment that we received from Takeda with respect to AMITIZA in October 2004. We characterized this payment as a milestone royalty and we expensed it as incurred.
 
We also have paid Sucampo AG $2.5 million, reflecting 5% of the aggregate of $50.0 million of development milestone payments that we received from Takeda through December 31, 2006, and $250,000 upon marketing approval of AMITIZA by the FDA for the treatment of chronic idiopathic constipation in adults. These payments were characterized as milestone royalties to related parties and were expensed as incurred.
 
We will be obligated to pay Sucampo AG $1.5 million, reflecting 5% of the $30.0 million milestone payment due to us from Takeda as a result of our submission to the FDA in June 2007 of the supplement to our existing NDA for AMITIZA seeking marketing approval for AMITIZA for the treatment of irritable bowel syndrome with constipation. We expect to expense the entire amount of this payment as milestone royalties to related parties in the quarter ended June 30, 2007.
 
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:
 
  •  $1.0 million upon entry into the arrangement, which we received in March 2003;
 
  •  $2.0 million upon commencement of a first Phase II clinical trial relating to AMITIZA to treat irritable bowel syndrome with constipation, which we received in April 2003; and
 
  •  $3.0 million upon commencement of a first Phase II clinical trial for the other compound, which we received in 2003. On March 31, 2005, after evaluating the Phase II study results, we determined to discontinue any further research and development related to this compound and will not receive any further payments in respect of this compound.
 
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 quarter ended June 30, 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. As of March 31, 2007, we had recognized a total of $419,000 as contract revenue from related parties under our exclusive supply arrangement with R-Tech.
 
The supply agreement also requires payment of a specified transfer price in respect of supplies of AMITIZA. Takeda is obligated to make such payment, without reimbursement from us, in respect of commercial supplies of AMITIZA for the territory covered by our collaboration with Takeda.
 
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 territory and, accordingly, the entire $2.0 million is reflected as deferred revenue at March 31, 2007.


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Discontinued Ophthalmic Collaborative Relationship
 
On February 1, 1999, we entered into a five-year collaboration agreement with an unrelated third party, which established a long-term alliance for the development and commercialization of drugs to treat ophthalmic diseases. Under this arrangement, we agreed to conduct preclinical tests, clinical tests and other research and development for designated compounds, all of which were unrelated to prostones. In turn, we received non-refundable payments totalling $8.0 million. We recognized these payments ratably over the term of the project, which approximated the term of the agreement. We recognized $67,000 in revenue under this agreement in 2004, which we characterized as contract revenue. All revenues related to this agreement were recognized by the first quarter of 2004. In 2004, we determined not to continue this relationship, and we allowed the collaboration agreement to expire.
 
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 accounting principles generally accepted in the United States of America. 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 estimate if:
 
  •  the nature of the estimate or assumption is material due to the level of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and
 
  •  the impact of the estimates and assumptions on financial condition or operating performance is material.
 
Our significant accounting policies are described in more detail in note 3 of our consolidated financial statements.
 
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”, EITF No. 99-19,Reporting Revenue Gross as a Principal Versus Net as an Agent”, and EITF No. 00-21,Revenue Arrangements with Multiple Deliverables”. 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 recognize 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


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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. We estimated this performance period would be completed by 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.
 
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. Because of the lack of historical data regarding sales returns, we do not report as revenue royalty payments related to the portion of sales by Takeda that are subject to a right of return until the right of return lapses.
 
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.
 
Other Revenue Sources
 
We recorded revenues from the performance of research and development cost reimbursement activities under the collaboration agreement for our discontinued opthalmic collaborative relationship over the period in which the actual research and development activities occurred, similar to the time-based model, which was equivalent to the term of the collaboration agreement.
 
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 Expenses
 
As part of our process of preparing our consolidated financial statements, we are required to estimate accrued 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, professional fees, such as accountants’ and attorneys’ fees, and payments to 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. We must make significant judgments and estimates in determining the accrued balance in any accounting period.
 
In connection with these service fees, our estimates are most affected by our understanding of the status and timing of services provided relative to the actual levels of services incurred by the service providers. The


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majority of our service providers invoice us monthly in arrears for services performed. In the event we do not identify costs that have begun to be incurred or we under-estimate or over-estimate the level of services performed or the costs of such services, our reported expenses for the relevant period would be too low or too high. We must also sometimes make judgments about the date on which services commence, the level of services performed on or before a given date and the cost of such services. We make these judgments based upon the facts and circumstances known to us in accordance with generally accepted accounting principles.
 
Stock-Based Compensation
 
Through December 31, 2005, we elected to follow Accounting Principles Board Opinion, or APB, No. 25, “Accounting for Stock Issued to Employees”, or APB 25, and related interpretations in accounting for our stock-based compensation plans, rather than the alternative fair value accounting method provided for under Statement of Financial Accounting Standards, or SFAS, No. 123, “Accounting for Stock-Based Compensation Accounting Principles Board Opinion”, or SFAS 123. Accordingly, we have not recorded stock-based compensation expense for stock options issued to employees in fixed amounts with exercise prices at least equal to the fair value of the underlying common stock on the date of grant, including those granted in 2004. We did not award stock options to employees in 2005, although we did award options to non-employees. In note 3 to our consolidated financial statements included later in this prospectus, we provide pro forma disclosures for the years presented in accordance with SFAS 123 and related pronouncements.
 
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 fair value of the equity instruments is calculated based on the guidance of SFAS 123. 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.
 
Given the lack of an active public market for our common stock, our board of directors determined the fair value of our class A common stock for stock option awards. Our board of directors determined this fair value. 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 requires making complex and subjective judgments. Our approach to valuation is based on a discounted future cash flow approach that uses our estimates of revenue, driven by assumed market growth rates, and estimated costs as well as appropriate discount rates. These estimates are consistent with the plans and estimates that we use to manage our business. There is inherent uncertainty in making these estimates. Although it is reasonable to expect that the completion of this offering will add value to the shares because they will have increased liquidity and marketability, the amount of additional value cannot be measured with precision or certainty.
 
In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123R, “Share-Based Payment”, or SFAS 123R, a revision of SFAS 123. SFAS 123R requires companies to recognize expense associated with share-based compensation arrangements, including employee stock options, using a fair value-based option-pricing model, and eliminates the alternative to use APB 25’s intrinsic-value method of accounting for share-based payments to employees. The standard generally allows two alternative transition methods in the year of adoption — prospective application and retroactive application with restatement of prior financial statements to include the same amounts that were previously included in the SFAS 123 pro forma


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disclosures. On January 1, 2006, we adopted SFAS 123R using the prospective method of implementation. According to the prospective transition method, the previously issued financial statements will not be adjusted.
 
We implemented SFAS 123R utilizing the prospective transition method. Under this method, we will recognize 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 123R, we have chosen to use:
 
  •  the straight-line method of allocating compensation cost under SFAS 123R;
 
  •  the Black-Scholes model as our chosen option-pricing model;
 
  •  the simplified method to calculate the expected term for options as discussed under SAB No. 7, “Share-Based Payment”; and
 
  •  an estimate of expected volatility based on the historical volatility of similar entities whose share prices are publicly available.
 
Our consolidated financial statements as of and for the year ended December 31, 2006 reflect the impact of adopting SFAS 123R. In accordance with the prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R, as all outstanding stock options as of January 1, 2006 were fully vested. During the three months ended March 31, 2007, we recognized stock-based compensation expense of $203,000 under SFAS 123R, which related to employee stock options granted in May 2006 and August 2006.
 
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. 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 have recorded a partial valuation allowance of $9.9 million as of December 31, 2006, which resulted in a net deferred tax asset of $4.9 million as of December 31, 2006, due to uncertainties related to our ability to utilize a portion of the deferred tax assets in years beyond 2007. Significant future events, including marketing approval by the FDA of AMITIZA for the treatment of irritable bowel syndrome with constipation, are not in our control and 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, 2006, we had foreign net operating loss carryforwards of $2.2 million. The foreign net operating loss carryforwards will begin to expire on December 31, 2010. As of December 31, 2006, we had U.S. general business tax credits of $4.4 million, which also may be available to offset future income tax liabilities and will expire if not utilized at various dates beginning December 31, 2022. We have recorded a partial valuation allowance as an offset to our net deferred tax assets due to the uncertainty in determining the


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timing of the realization of certain tax benefits. In the event that we determine that we will be able to realize all or a portion of these assets, we will make an adjustment to the valuation allowance. The Tax Reform Act of 1986 contains provisions that may limit our ability to use our credits available in any given year in which there has been a substantial change in ownership interest, as defined. The realization of the benefits of the tax credits is dependent on sufficient taxable income in future years. Lack of earnings, a change in the ownership of our company, or the application of the alternative minimum tax rules could adversely affect our ability to utilize these tax credits.
 
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.
 
Results of Operations
 
Comparison of three months ended March 31, 2006 and March 31, 2007
 
     Revenues
 
The following table summarizes our revenues for the three months ended March 31, 2006 and 2007:
 
                 
    Three Months Ended
 
    March 31,  
    2006     2007  
    (Restated)        
    (in thousands)  
 
Research and development revenue
  $ 22,441     $ 9,366  
Contract revenue
    1,500        
Collaboration revenue
    37       37  
Contract revenue — related parties
    29       116  
Product royalty revenue
          2,309  
Co-promotion revenue
    161       1,132  
                 
Total
  $ 24,168     $ 12,960  
                 
 
Total revenues were $13.0 million for the three months ended March 31, 2007 compared to $24.2 million for the three months ended March 31, 2006, a decrease of $11.2 million. This decrease was primarily due to a decrease in payments received from Takeda for research and development services performed by us.
 
Research and development revenue was $9.4 million for the three months ended March 31, 2007 compared to $22.4 million for the three months ended March 31, 2006, a decrease of $13.0 million. This decrease was primarily due to our progress in the development of AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation and the recognition of payments previously received from Takeda. We recognize our revenue for this development work ratably over the estimated performance period associated with the development of AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation. We initially estimated the development period would be completed in December 2006. As a result of new study evaluation requirements released by the Rome III Committee on Functional Gastrointestinal Disorders, an international committee of gastroenterologists, we concluded in June 2006 that the completion of the development period would not occur until May 2007. During the three months ended March 31, 2007, we extended the estimated completion of the development period from May 2007 to June 2007 as a result of discussions with Takeda. These determinations to extend the estimated completion date from December 2006 to May 2007 and then to June 2007 had the effect of lengthening the period over which any revenue not then recognized would be recognized.


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The specific revenue streams associated with research and development revenue for the three months ended March 31, 2006 and 2007 were as follows:
 
  •  In March and May 2005, we received development milestone payments from Takeda totaling
$30.0 million related to our efforts to develop AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation. We are recognizing these payments as research and development revenue ratably over the performance period, resulting in $3.5 million of research and development revenue for the three months ended March 31, 2006 and $1.9 million for the three months ended March 31, 2007. The smaller amount of revenue recognized for the three months ended March 31, 2007 is a result of our determinations to extend the estimated completion of the development period.
 
  •  In January 2006, we received a $20.0 million development milestone payment from Takeda related to our efforts to develop AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation, which we are recognizing as research and development revenue ratably over the performance period, resulting in $13.1 million of research and development revenue for the three months ended March 31, 2006 and $1.2 million for the three months ended March 31, 2007. We recognized a significant portion of this milestone payment in the three months ended March 31, 2006, the quarter in which it was received, reflecting the fact that we were then well into the estimated development period. The smaller amount of revenue for the three months ended March 31, 2007 also reflects our determinations, subsequent to our receipt of this payment, to extend the estimated completion of the development period.
 
  •  We have received a total of $30.0 million of reimbursement payments for research and development costs from Takeda related to our efforts to develop AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation, which we are recognizing as research and development revenue ratably over the performance period, resulting in $3.5 million of research and development revenue for the three months ended March 31, 2006 and $1.9 million for the three months ended March 31, 2007. The smaller amount of revenue recognized for the three months ended March 31, 2007 is a result of our determinations to extend the estimated completion of the development period.
 
  •  In October 2004, we received an up-front payment of $20.0 million from Takeda, of which $17.6 million was associated with the development of AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation. This amount is being recognized ratably over the estimated performance period, resulting in $2.0 million of research and development revenue for the three months ended March 31, 2006 and $1.1 million for the three months ended March 31, 2007. The smaller amount of revenue recognized for the three months ended March 31, 2007 is a result of our determination in June 2006 to extend the estimated completion of the development period from December 2006 to May 2007.
 
  •  We also began to perform services and receive payments from Takeda during the third quarter of 2006 for the following three deliverables: post-marketing studies to evaluate the safety of AMITIZA in patients with renal impairment and patients with hepatic impairment, Phase IV 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. Total research and development revenue associated with these three deliverables for the three months ended March 31, 2007 was $3.3 million.
 
We had no contract revenue for the three months ended March 31, 2007, compared to $1.5 million for the three months ended March 31, 2006. Contract revenue represents amounts released from previously deferred revenue that we recognized upon the expiration of the option granted to Takeda for joint development and commercialization rights for AMITIZA in Europe, Africa and the Middle East. We recognized all of this deferred revenue in the three months ended March 31, 2007.
 
Upon receipt of the $20.0 million up-front payment in 2004, we deferred $2.4 million to be recognized using the time-based model over the 16-year performance period of our participation in the committee meetings. During each of the three months ended March 31, 2006 and 2007, we recognized $37,000 of this deferred amount as collaboration revenue.


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Contract revenue from 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. Contract revenue from related parties was $116,000 for the three months ended March 31, 2007 compared to $29,000 for the three months ended March 31, 2006, an increase of $87,000.
 
Product royalty revenue represents payments received from Takeda relating to net sales of AMITIZA. We began to recognize the royalty payments from Takeda as revenue in the second quarter of 2006 following the product launch of AMITIZA. For the three months ended March 31, 2007, we recognized $2.3 million of product royalty 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. For the first quarter of 2006, we received approximately $161,000 in reimbursement of costs for miscellaneous marketing activities. We began to receive reimbursement of costs for our sales force in the second quarter of 2006 following the product launch of AMITIZA. For the three months ended March 31, 2007, we recognized $1.1 million of co-promotion revenues, of which approximately $158,000 was for reimbursement of costs for miscellaneous marketing activities and $974,000 was for reimbursement of sales force costs.
 
In June 2007, we submitted a supplement to our existing NDA for AMITIZA to the FDA seeking marketing approval for AMITIZA for the treatment of irritable bowel syndrome with constipation. As a result of this submission, Takeda is required by the terms of our collaboration agreement with them to make a $30.0 million milestone payment to us. We expect to recognize the entire amount of this payment as research and development revenue in the quarter ended June 30, 2007, reflecting the end of the development period for AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation.
 
      Research and Development Expenses
 
Research and development expenses represent costs incurred in connection with the in-licensing of our compounds, clinical trials, activities associated with regulatory filings and manufacturing efforts. Currently, we outsource our clinical trials to independent contract research organizations in order to minimize our overhead. We expense our research and development costs as incurred.
 
Total research and development expenses for the three months ended March 31, 2007 were $5.9 million compared to $6.1 million for the three months ended March 31, 2006, a decrease of $174,000. In the three months ended March 31, 2006 and 2007, our research and development expenses were primarily those associated with the ongoing Phase III clinical trials of AMITIZA for the treatment of irritable bowel syndrome with constipation.
 
It is not practical for us to break out historical research and development expenses by research project or by compound for several reasons. First, clinical trials conducted with respect to a single compound, such as AMITIZA, typically produce data and information that is applicable to more than one indication. Second, clinical trials on one compound may produce data and information that is applicable to other compounds, particularly given the relatively similar nature of several of our prostone compounds. Finally, we have not historically maintained records that allocate research and development costs among different compounds, indications or projects.
 
We consider the continued development of our product pipeline crucial to our success, and we anticipate that our research and development costs will continue to increase as we advance our research and development activities associated with our product candidates.
 
Following the closing of this offering, we are obligated to assume the filing and maintenance costs relating to the patent portfolio licensed by us from Sucampo AG. In addition, following this offering, we will be obligated under our license agreement with Sucampo AG to incur at least $1.0 million annually to develop compounds other than AMITIZA, SPI-8811 and SPI-017. We estimate that these costs will increase our research and developments expenses by approximately $1.7 million per year. We began to incur patent maintenance costs in late 2006.


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The successful development of our product candidates is highly uncertain. At this time, we cannot reasonably estimate or know the nature, timing and estimated costs of the efforts that will be necessary to complete the remainder of the development of, or the period, if any, in which material net cash inflows may commence from, any of our product candidates. This is due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of:
 
  •  the scope, rate of progress and expense of our clinical trials and other research and development activities;
 
  •  the potential benefits of our product candidates over other therapies;
 
  •  our ability to market, commercialize and achieve market acceptance for any of our product candidates that we are developing or may develop in the future;
 
  •  future clinical trial results;
 
  •  the terms and timing of regulatory approvals; and
 
  •  the expense of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights.
 
A change in the outcome of any of these variables with respect to the development of a product candidate could mean a significant change in the costs and timing associated with the development of that product candidate. For example, if the FDA or other regulatory authority were to require us to conduct clinical trials beyond those that we currently anticipate will be required for the completion of clinical development of a product candidate or if we experience significant delays in enrollment in any of our clinical trials, we could be required to expend significant additional financial resources and time on the completion of clinical development.
 
     General and Administrative Expenses
 
General and administrative expenses consist primarily of expenses for salaries and related personnel costs and expenses for corporate activities.
 
The following table summarizes our general and administrative expenses for the three months ended March 31, 2006 and 2007:
 
                 
    Three Months Ended
 
    March 31,  
    2006     2007  
    (Restated)        
    (in thousands)  
 
Salaries, benefits and related costs
  $ 1,389     $ 1,547  
Legal and consulting expenses
    893       720  
Other operating expenses
    686       567  
                 
Total
  $ 2,968     $ 2,834  
                 
 
General and administrative expenses were $2.8 million for the three months ended March 31, 2007 compared to $3.0 million for the three months ended March 31, 2006, a decrease of $134,000. This decrease was due primarily to a cumulative out-of-period adjustment of $358,000 that we recorded during the three months ended March 31, 2007 to reduce stock-based compensation expense that we had previously recorded for the year ended December 31, 2006. This adjustment, which reduced our general and administrative expenses for the three months ended March 31, 2007, was offset in part by approximately $224,000 of increased general and administrative expenses related to increases in operational headcount and costs related to our operation of Sucampo Europe and Sucampo Japan, whose capital stock we acquired in September 2006. We expect to incur significant increases in our general and administrative expenses as we adopt public reporting requirements, implement enhanced financial reporting controls to comply with Sarbanes-Oxley and improve consolidation procedures and controls related to Sucampo Europe and Sucampo Japan.


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In June 2007, the compensation committee of our board of directors authorized a one-time stock and cash award to each of Drs. Kuno and Ueno, which will be settled immediately following this offering. These awards are described in more detail under the caption “Certain Relationships and Related Party Transactions — Special Stock and Cash Awards to Drs. Kuno and Ueno”. The value of these awards will depend upon the public offering price per share in this offering. Assuming a public offering price of $15.00 per share, the midpoint of the price range set forth on the cover of this prospectus, the aggregate value of these grants would be $10.2 million. We expect to record general and administrative expense for the quarter ended June 30, 2007 equal to the aggregate value of these awards, calculated assuming a public offering price per share in this offering of $15.00. If the actual public offering price is higher or lower than $15.00 per share, we will record additional general and administrative expense or a reduction in general and administrative expense, respectively, for the quarter in which we complete this offering. The amount of this additional expense or expense reduction will be equal to the difference between the actual amount of the cash portion of the awards and the expense we originally recorded for the cash portion. The expense related to the stock portion of these awards will be fixed based on the fair value at the grant date, which is deemed to be June 29, 2007, when Drs. Kuno and Ueno agreed to the terms of the awards.
 
      Selling and Marketing Expenses
 
Selling and marketing expenses represent costs we incur to co-promote AMITIZA and other selling and marketing expenses, including costs for market research and analysis, marketing and promotional materials, product samples and other costs.
 
Selling and marketing expenses were $3.2 million for the three months ended March 31, 2007 compared to $948,000 for the three months ended March 31, 2006, an increase of $2.3 million. During the three months ended March 31, 2006, the selling and marketing expenses we incurred were primarily in anticipation of our commercial launch of AMITIZA in April 2006. These expenses were significantly less than those we incurred during the three months ended March 31, 2007, when our co-promotion efforts were fully operational.
 
In connection with our termination of our contract sales agreement with Ventiv and our internalization of our specialty sales force, we expect to incur approximately $250,000 of transition expenses, primarily recruiting and training expenses and a termination fee we will pay to Ventiv, which will affect our selling and marketing expenses for the quarter ending September 30, 2007. We also anticipate that our ongoing expenses relating to this sales force will increase by approximately $400,000 annually over what those expenses would have been if we had maintained the Ventiv relationship, due to compensation increases we expect to implement.
 
      Milestone Royalties to Related Parties
 
Milestone royalties to related parties were $1.3 million for the three months ended March 31, 2006. In the three months ended March 31, 2006, we paid Sucampo AG $1.0 million, reflecting the 5% we owed them in respect of 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. We did not pay any milestone royalties to related parties in the three months ended March 31, 2007.
 
We will be obligated to pay Sucampo AG $1.5 million, reflecting 5% of the $30.0 million milestone payment due to us from Takeda as a result of our submission in June 2007 of the supplement to our existing NDA for AMITIZA seeking marketing approval for AMITIZA for the treatment of irritable bowel syndrome with constipation. We expect to expense the entire amount of this payment as milestone royalties to related parties in the quarter ended June 30, 2007.
 
Product Royalties to Related Parties
 
Product royalties to related parties represent our obligation to pay Sucampo AG a royalty of 3.2% of net sales of AMITIZA in North, Central and South America, including the Caribbean. The product royalties that we pay to Sucampo AG are based on total product net sales, whether by us or a sublicensee, and not on amounts actually received by us. 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 the quarter ended March 31, 2007, we expensed $410,000 in product royalties to related parties. Accordingly, we did not owe any product royalties to related parties for the three months ended March 31, 2006.


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     Non-Operating Income and Expense
 
The following table summarizes our non-operating income and expense for the three months ended March 31, 2006 and 2007:
 
                 
    Three Months Ended
 
    March 31,  
    2006     2007  
    (Restated)        
    (in thousands)  
 
Interest income
  $ 306     $ 324  
Interest expense
    (20 )     (4 )
Other income (expense), net
    139       (2 )
                 
Total, net
  $ 425     $ 318  
                 
 
Interest income was $324,000 for the three months ended March 31, 2007 compared to $306,000 for the three months ended March 31, 2006, an increase of $18,000. The increase was primarily due to an increase in the funds available for investment. Interest expense was $4,000 for the three months ended March 31, 2007 compared to $20,000 for the three months ended March 31, 2006, a decrease of $16,000. This decrease reflected our repayment in full in June 2006 of related party debt instruments issued by Sucampo Japan and Sucampo Europe. Other income (expense), net represents foreign currency exchange gains and losses, which we expect will fluctuate from period to period.
 
      Income Taxes
 
For the three months ended March 31, 2006 and 2007, our consolidated effective tax rate was 0.0% and 39.7%, respectively. The change in the effective tax rate for the three months ended March 31, 2007 from the three months ended March 31, 2006 was due primarily to the utilization of approximately $340,000 in U.S. deferred tax assets. The utilization of our U.S. deferred tax assets for the three months ended March 31, 2006 was offset by a corresponding release of our valuation allowance.
 
Comparison of years ended December 31, 2005 and December 31, 2006
 
      Revenues
 
The following table summarizes our revenues for the years ended December 31, 2005 and 2006:
 
                 
    Year Ended
 
    December 31,  
    2005     2006  
    (Restated)        
    (in thousands)  
 
Research and development revenue
  $ 38,960     $ 46,382  
Contract revenue
    1,000       1,500  
Collaboration revenue
    147       147  
Contract revenue — related parties
    98       404  
Product royalty revenue
          6,591  
Co-promotion revenue
          4,243  
                 
Total
  $ 40,205     $ 59,267  
                 
 
Total revenues were $59.3 million in 2006 compared to $40.2 million in 2005, an increase of $19.1 million. This increase was primarily due to an increase in payments received from Takeda for research and development services performed by us, product royalties from AMITIZA sales, and reimbursements of co-promotion efforts performed by us to market and sell AMITIZA.
 
Research and development revenue was $46.4 million for the year ended December 31, 2006 compared to $39.0 million for the year ended December 31, 2005, an increase of $7.4 million. The specific revenue streams


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associated with research and development revenue for the years ended December 31, 2005 and 2006 were as follows:
 
  •  In March and May 2005, we received development milestone payments from Takeda totaling
$30.0 million related to our efforts to develop AMITIZA. These payments are being recognized as research and development revenue ratably over the performance period, resulting in $16.2 million of research and development revenue in 2005 and $10.5 million in 2006. The smaller amount of revenue recognized in 2006 is a result of our determination in June 2006 to extend the estimated completion of the development period from December 2006 to May 2007.
 
  •  In January 2006, we received a $20.0 million development milestone payment from Takeda related to our efforts to develop AMITIZA, which is being recognized as research and development revenue ratably over the performance period, resulting in $17.8 million of research and development revenue in 2006.
 
  •  During the year ended December 31, 2005, we received a total of $28.5 million of reimbursement payments for research and development costs from Takeda related to our efforts to develop AMITIZA, which are being recognized as research and development revenue ratably over the performance period, resulting in $14.7 million of research and development revenue in 2005 and $10.5 million in 2006. The smaller amount of revenue recognized in 2006 is a result of our determination in June 2006 to extend the estimated completion of the development period.
 
  •  In October 2004, we received an up-front payment of $20.0 million from Takeda, of which $17.6 million was associated with the development of AMITIZA. This amount is being recognized ratably over the estimated performance period, resulting in $8.1 million of research and development revenue during 2005 and $6.2 million during 2006. The smaller amount of revenue recognized in 2006 is a result of our determination in June 2006 to extend the estimated completion of the development period.
 
  •  We also began to perform services and receive payments from Takeda during the year ended December 31, 2006 for the following three deliverables: post-marketing studies to evaluate the safety of AMITIZA in patients with renal impairment and patients with hepatic impairment, Phase IV 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. Total research and development revenue associated with these three deliverables during 2006 was $1.1 million.
 
Contract revenue was $1.5 million for the year ended December 31, 2006 compared to $1.0 million for the year ended December 31, 2005, an increase of $500,000. Contract revenue represents amounts released from previously deferred revenue that we recognized upon the expiration of the option granted to Takeda for joint development and commercialization rights for AMITIZA in Europe, Africa and the Middle East.
 
Upon receipt of the $20.0 million up-front payment, we deferred $2.4 million to be recognized using the time-based model over the 16-year performance period of our participation in the committee meetings. During each of the years ended December 31, 2005 and 2006, we recognized $147,000 of this deferred amount as collaboration revenue.
 
Contract revenue from 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. Contract revenue from related parties was $404,000 for the year ended December 31, 2006 compared to $98,000 for the year ended December 31, 2005, an increase of $306,000.
 
Product royalty revenue represents payments received from Takeda relating to net sales of AMITIZA. We began to recognize the royalty payments from Takeda as revenue in the second quarter of 2006 following the product launch of AMITIZA. In the year ended December 31, 2006, we recognized $6.6 million of product royalty revenue. Of this product royalty revenue, we recognized $4.5 million in the quarter ended June 30, 2006, which reflected stocking purchases by drug wholesalers to establish their initial inventory levels, and therefore these revenues may not be indicative of product royalty revenue levels that we may achieve in future periods.
 
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. We began to receive reimbursement of these expenses in the second quarter of 2006 following the


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product launch of AMITIZA. In the year ended December 31, 2006, we recognized $4.2 million of co-promotion revenues.
 
      Research and Development Expenses
 
Total research and development expenses for the year ended December 31, 2006 were $16.4 million compared to $31.2 million for the year ended December 31, 2005, a decrease of $14.8 million. The higher costs in 2005 reflect the significant research and development expenses incurred by us during that period in connection with the filing of the NDA for AMITIZA to treat chronic idiopathic constipation in adults and the initiation of Phase III clinical trials of AMITIZA for the treatment of irritable bowel syndrome with constipation. In 2006, our research and development expenses were primarily those associated with the ongoing Phase III clinical trials of AMITIZA for the treatment of irritable bowel syndrome with constipation.
 
      General and Administrative Expenses
 
The following summarizes our general and administrative expenses for the years ended December 31, 2005 and 2006:
 
                 
    Year Ended
 
    December 31,  
    2005     2006  
    (in thousands)  
 
Salaries, benefits and related costs
  $ 3,843     $ 5,342  
Legal and consulting expenses
    1,565       3,356  
Stock-based compensation
    138       2,708  
Other operating expenses
    2,214       3,181  
                 
Total
  $ 7,760     $ 14,587  
                 
 
General and administrative expenses were $14.6 million for the year ended December 31, 2006 compared to $7.8 million for the year ended December 31, 2005, an increase of $6.8 million. This increase was due primarily to recognition of $2.7 million in stock-based compensation expenses following our adoption of SFAS 123R in January 2006, increases in operational headcount, rent for additional leased office space and a one-time bonus payment to our employees upon receipt of marketing approval for AMITIZA to treat chronic idiopathic constipation in adults, as well as professional fees in connection with our acquisition of the capital stock of Sucampo Europe and Sucampo Japan.
 
      Selling and Marketing Expenses
 
Selling and marketing expenses were $11.1 million for the year ended December 31, 2006 compared to $295,000 for the year ended December 31, 2005, an increase of $10.8 million. This increase was due to costs we incurred to launch AMITIZA in April 2006 and other selling and marketing expenses through the remainder of 2006, including costs for market research and analysis, marketing and promotional materials, product samples and other costs.
 
      Milestone Royalties to Related Parties
 
Milestone royalties to related parties were $1.3 million for the year ended December 31, 2006 compared to $1.5 million for the year ended December 31, 2005, a decrease of $200,000. In the year ended December 31, 2006, we paid Sucampo AG $1.0 million, reflecting the 5% we owed them in respect of 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. In the year ended December 31, 2005, we paid Sucampo AG $1.5 million, reflecting the 5% we owed them in respect of the $30.0 million development milestone payments we received from Takeda during that period.


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Product Royalties to 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 the year ended December 31, 2006, we expensed $1.2 million in product royalties to related parties.
 
      Non-Operating Income and Expense
 
The following table summarizes our non-operating income and expense for the years ended December 31, 2005 and 2006:
 
                 
    Year Ended
 
    December 31,  
    2005     2006  
    (in thousands)  
 
Interest income
  $ 1,046     $ 1,976  
Interest expense
    (311 )     (90 )
Other income
    255       255  
                 
Total, net
  $ 990     $ 2,141  
                 
 
Interest income was $2.0 million for the year ended December 31, 2006 compared to $1.0 million for the year ended December 31, 2005, an increase of $1.0 million. 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 March 2005, May 2005 and January 2006. Interest expense was $90,000 for the year ended December 31, 2006 compared to $311,000 for the year ended December 31, 2005, a decrease of $221,000. This decrease reflected our repayment in full in December 2005 and June 2006 of related party debt instruments issued by Sucampo Japan and Sucampo Europe.
 
      Income Taxes
 
For the years ended December 31, 2005 and 2006, our consolidated effective tax rate was 166.7% and (29.0%), respectively. The change in the effective tax rate for the year ended December 31, 2006 from the year ended December 31, 2005 was due primarily to the discrete release of $4.9 million from the valuation allowance on a portion of the U.S. deferred tax assets that we believe is more likely than not to be realized.
 
Comparison of years ended December 31, 2004 and December 31, 2005
 
      Revenues
 
The following table summarizes our revenues for the years ended December 31, 2004 and 2005:
 
                 
    Year Ended
 
    December 31,  
    2004     2005  
    (Restated)     (Restated)  
    (in thousands)  
 
Research and development revenue
  $ 2,838     $ 38,960  
Contract revenue
    69       1,000  
Collaboration revenue
    24       147  
Contract revenue — related parties
    411       98  
Other income — gain on sale of patent to related party
    497        
                 
Total
  $ 3,839     $ 40,205  
                 
 
Total revenues were $40.2 million in 2005 compared to $3.8 million in 2004, an increase of $36.4 million. This increase was primarily due to an increase in payments received from Takeda for research and development services performed by us relating to AMITIZA.


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Research and development revenue was $39.0 million for the year ended December 31, 2005 compared to $2.8 million for the year ended December 31, 2004, an increase of $36.2 million. This increase was primarily due to our progress in the development of AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation and the recognition of payments received from Takeda related to our development work ratably over the estimated development period, which was previously estimated to be completed by December 2006. The specific revenue streams associated with research and development revenue for the years ended December 31, 2004 and 2005 were as follows:
 
  •  During the year ended December 31, 2005, we received $30.0 million of development milestone payments from Takeda related to our efforts to develop AMITIZA, which are being recognized as research and development revenue ratably over the performance period, resulting in $16.2 million of revenue during 2005. No development milestones were received and recognized as revenue during the year ended December 31, 2004.
 
  •  We received $1.5 million and $28.5 million of reimbursement payments for research and development costs from Takeda related to our efforts to develop AMITIZA during the years ended December 31, 2004 and 2005, respectively. We recognized the full $1.5 million as research and development revenue during 2004 and are recognizing the $28.5 million ratably over the development period, resulting in $14.7 million of research and development revenue during 2005.
 
  •  During the year ended December 31, 2004, we received an up-front payment of $20.0 million from Takeda, of which $17.6 million was associated with the development of AMITIZA. This amount is being recognized ratably over the estimated performance period to develop AMITIZA, resulting in $1.4 million and $8.1 million of research and development revenue during the years ended December 31, 2004 and 2005, respectively.
 
During the year ended December 31, 2005, we received $30.0 million of development milestone payments and $28.5 million of reimbursement payments for research and development costs from Takeda related to our efforts to develop AMITIZA. Because these amounts were received during 2005, we recognized a partial year of research and development revenue for the year ended December 31, 2005. During 2005, we also received a $20.0 million development milestone payment for our related efforts to develop AMITIZA, which will be recognized through the end of the performance period. Total research and development revenue associated with the development of AMITIZA to treat chronic idiopathic constipation and irritable bowel syndrome with constipation was $39.0 million for the year ended December 31, 2005. In 2004, we did not receive any development milestone payments.
 
We recognized contract revenue of $69,000 in 2004 and $1.0 million in 2005. Contract revenue in 2004 included the $67,000 we recognized with respect to the terminated ophthalmic collaboration agreement. Contract revenue in 2005 included $1.0 million in previously deferred revenue that we recognized during this period upon the expiration of the option granted to Takeda for joint development and commercialization rights for AMITIZA in Asia.
 
Upon receipt of the $20.0 million up-front payment, we deferred $2.4 million to be recognized using the time-based model over the 16-year performance period of our participation in the committee meetings. During the years ended December 31, 2004 and 2005, we recognized $24,000 and $147,000, respectively, of this deferred amount as collaboration revenue.
 
We received $411,000 in contract revenue from related parties in 2004, including $324,000 from Sucampo AG for consulting services and $87,000 from R-Tech for manufacturing and research and development consulting services. We received $98,000 of contract revenue from related parties in 2005, reflecting payments from R-Tech for manufacturing and research and development consulting services.
 
In 2004, we also recognized a one-time gain of $497,000 upon the sale to Sucampo AG of U.S. patents relating to RESCULA. As a result of declining royalty revenues associated with these patents, we determined that we would be unable to recover the original $954,865 purchase price paid for these patents and sold our rights in them to Sucampo AG.


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      Research and Development Expenses
 
Total research and development expenses were $31.2 million in 2005 compared to $14.0 million in 2004, an increase of $17.1 million. This increase was due primarily to costs associated with the commencement in May 2005 of two pivotal Phase III clinical trials of AMITIZA for the treatment of irritable bowl syndrome with constipation and a related follow-on safety trial.
 
In 2005, we incurred $3.4 million in research and development expenses for services performed by third-party consultants, whom we compensated by granting stock options at the time services were rendered. We determined the value of these options to be $3.4 million, and we recognized the related expense in full in the period of the grant.
 
      General and Administrative Expenses
 
The following summarizes our general and administrative expenses for the years ended December 31, 2004 and 2005:
 
                 
    Year Ended
 
    December 31,  
    2004     2005  
    (in thousands)  
 
Salaries, benefits and related costs
  $ 4,160     $ 3,843  
Legal and consulting expenses
    2,131       1,565  
Stock-based compensation
    68       138  
Other operating expenses
    1,857       2,214  
                 
Total
  $ 8,216     $ 7,760  
                 
 
General and administrative expenses were $7.8 million in 2005 compared to $8.2 million in 2004, a decrease of $456,000. Stock-based compensation was $138,000 in 2005 compared to $68,000 in 2004, an increase of $70,000. This increase was due primarily to a modification in 2005 of the vesting of previously issued stock options and the resulting stock-based compensation expense in 2005.
 
      Selling and Marketing Expenses
 
Selling and marketing expenses were $295,000 for 2005 compared to zero for 2004. The expenses in 2005 were primarily attributable to the following:
 
  •  the hiring of two members of our senior marketing staff, consisting of a vice-president of marketing and sales, hired in September 2005, and a director of marketing, hired in June 2005; and
 
  •  expenses for market research and analysis conducted in anticipation of potential marketing approval by the FDA of AMITIZA for the treatment of chronic idiopathic constipation in adults.
 
      Milestone Royalties to Related Parties
 
During 2005, we paid Sucampo AG $1.5 million reflecting the 5% we owed them in respect of the $30.0 million of development milestone payments we received from Takeda during the year. We paid $1.0 million in milestone royalty payments during 2004 related to the $20.0 million up-front payment we received from Takeda.


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      Non-Operating Income and Expense
 
The following table summarizes our non-operating income and expense for the years ended December 31, 2004 and 2005:
 
                 
    Year Ended
 
    December 31,  
    2004     2005  
    (in thousands)  
 
Interest income
  $ 96     $ 1,046  
Interest expense
    (173 )     (311 )
Other income
    21       255  
                 
Total, net
  $ (56 )   $ 990  
                 
 
Interest income was $1.0 million in 2005 compared to $96,000 in 2004, an increase of $950,000. 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 of $10.0 million in March 2005 and $20.0 million in May 2005. We invested these funds in short-term auction-rate securities. Interest expense was $311,000 in 2005 compared to $174,000 in 2004, an increase of $137,000. The increase in other income was due primarily to foreign currency transaction gains of $248,000 during 2005. This increase was attributable to increased borrowings under notes to related parties.
 
     Income Taxes
 
The income tax provision was $788,000 for the year ended December 31, 2005 compared to $0 for the year ended December 31, 2004. The increase of $788,000 resulted from taxes payable on income we recognized during the year ended December 31, 2005 for tax purposes, which we were not able to offset with tax loss carryforwards or realize through future carrybacks. Our U.S. tax loss carryforwards were fully utilized as of December 31, 2005.
 
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.
 
                                         
                      Intercompany
       
    United States     Europe     Japan     Eliminations     Consolidated  
    (in thousands)  
 
Three months ended March 31, 2007
                                       
Total revenues
  $ 12,949     $     $ 221     $ (210 )   $ 12,960  
Income (loss) from operations
    724       (165 )     (20 )           539  
Income (loss) before income taxes
    1,041       (168 )     (16 )           857  
Identifiable assets (end of period)
    64,160       351       2,556       (4,899 )     62,168  
                                         
Three months ended March 31, 2006
                                       
Total revenues (restated)
  $ 22,639     $ 1,500     $ 29     $     $ 24,168  
Income (loss) from operations (restated)
    11,558       1,345       (21 )           12,882  
Income (loss) before income taxes (restated)
    11,876       1,337       78       16       13,307  
                                         
Year Ended December 31, 2006
                                       
Total revenues
  $ 57,677     $ 1,500     $ 161     $ (71 )   $ 59,267  
Income (loss) from operations
    13,974       980       (190 )     (1 )     14,763  
Income (loss) before income taxes
    16,020       934       (52 )     2       16,904  
Identifiable assets (end of period)
    68,943       496       2,544       (4,899 )     67,084  


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                      Intercompany
       
    United States     Europe     Japan     Eliminations     Consolidated  
    (in thousands)  
 
Year Ended December 31, 2005
                                       
Total revenues (restated)
  $ 39,107     $     $ 1,098     $     $ 40,205  
Income (loss) from operations (restated)
    115       (1,475 )     843             (517 )
Income (loss) before income taxes (restated)
    899       (1,437 )     1,011             473  
Identifiable assets (end of period) (restated)
    45,366       1,363       2,576       (1,320 )     47,985  
                                         
Year Ended December 31, 2004
                                       
Total revenues (restated)
  $ 4,170     $     $ 82     $ (413 )   $ 3,839  
Loss from operations (restated)
    (15,557 )     (2,424 )     (1,432 )           (19,413 )
Loss before income taxes (restated)
    (15,702 )     (2,628 )     (1,139 )           (19,469 )
 
Liquidity and Capital Resources
 
Sources of Liquidity
 
We require cash principally to meet our operating expenses. We have financed our operations since inception with a combination of private placements of equity securities, up-front and milestone payments received from Takeda, R-Tech and the third party with whom we entered into our discontinued ophthalmic collaboration, and research and development expense reimbursements from Takeda. From inception through March 31, 2007, we had raised net proceeds of $55.3 million from private equity financings. From inception through March 31, 2007, we had also received an aggregate of $110.5 million in up-front, milestone, option and expense reimbursement payments from third parties. We operated profitably in the year ended December 31, 2006 and the three months ended March 31, 2007, principally as a result of the development milestone payments that we received from Takeda. As of March 31, 2007, we had cash and cash equivalents and short-term investments of $45.1 million. We began receiving cash royalty payments from Takeda for AMITIZA sales in the quarter ended September 30, 2006.
 
Cash Flows
 
The following table summarizes our cash flows for the years ended December 31, 2004, 2005 and 2006 and the three months ended March 31, 2006 and 2007:
 
                                         
          Three Months
 
    Year Ended
    Ended
 
    December 31,     March 31,  
    2004     2005     2006     2006     2007  
    (in thousands)  
 
Cash provided by (used in):
                                       
Operating activities
  $ 3,210     $ 23,815     $ (10,914 )   $ 6,527     $ (6,353 )
Investing activities
    (3,016 )     (25,474 )     (1,413 )     (108 )     (99 )
Financing activities
    2,292       (2,278 )     17,421       20,501       (361 )
Effect of exchange rates
    362       (545 )     (49 )     (4 )     24  
                                         
Net increase (decrease) in cash and cash equivalents
  $ 2,848     $ (4,482 )   $ 5,045     $ 26,916     $ (6,789 )
                                         

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Three months ended March 31, 2007
 
Net cash used by operating activities was $6.4 million for the three months ended March 31, 2007. This reflected net income of $516,000. We had an increase in accounts receivable of $1.4 million, primarily related to product royalty revenue for AMITIZA and co-promotion revenues from Takeda and a decrease in deferred revenue of $6.2 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 $99,000 for the three months ended March 31, 2007. This primarily reflected our purchases of property and equipment.
 
Net cash used in financing activities was $361,000 for the three months ended March 31, 2007. This reflected payments incurred for our planned initial public offering.
 
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 an increase in accounts receivable of $2.8 million, primarily related to product royalty revenue for AMITIZA and co-promotion revenues from Takeda, 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. The decrease of other liabilities of $1.5 million was the result of our repayment to Takeda of $1.5 million for the refundable portion of its option payment upon the expiration of its option to negotiate commercialization rights for AMITIZA in Europe, the Middle East and Africa.
 
Net cash used in investing activities was $1.4 million for the year ended December 31, 2006. This reflected our purchases of auction rate securities and property and equipment of $2.5 million, offset in part by proceeds received from sales and maturities of auction rate securities 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 282,207 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 planned initial public offering and $4.8 million of repayments under related party debt instruments.
 
Year ended December 31, 2005 (Restated)
 
Net cash provided by operating activities was $23.8 million for the year ended December 31, 2005. This reflected a net loss of $316,000, an increase in our deferred revenue of $20.4 million from research and development payments from Takeda to be amortized over the performance period of the development of AMITIZA and $3.6 million of non-cash stock-based compensation charges.
 
Net cash used in investing activities was $25.5 million for the year ended December 31, 2005, reflecting our net purchase of $25.4 million in auction rate securities.
 
Net cash used in financing activities was $2.3 million for the year ended December 31, 2005, reflecting our repayment of related party debt.
 
Year ended December 31, 2004 (Restated)
 
Net cash provided by operating activities was $3.2 million for the year ended December 31, 2004. This reflected a net loss of $19.5 million and an increase in our deferred revenue of $20.4 million arising primarily from an up-front payment from Takeda, of which $2.4 million is being recognized over the 16-year period in which we are required to participate in collaboration committee meetings with Takeda and $17.6 million is being recognized over the performance period of our development of AMITIZA.


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Net cash used in investing activities was $3.0 million for the year ended December 31, 2004, reflecting our purchase of auction rate securities.
 
Net cash provided by financing activities was $2.3 million for the year ended December 31, 2004, reflecting funds received from borrowings under related party debt instruments.
 
Commitments and Contingencies
 
As of March 31, 2007, 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:
 
                                                         
    2007     2008     2009     2010     2011     Thereafter     Total  
    (in thousands)  
 
Contractual obligations:
                                                       
Operating leases
  $ 829     $ 1,429     $ 1,321     $ 969     $ 938     $ 5,159     $ 10,645  
 
The above table does not include:
 
  •  Contingent milestone and royalty obligations under our license agreement with Sucampo AG. These obligations are described in more detail above, and include obligations to pay Sucampo AG:
 
  •  5% of every milestone payment we receive from a sublicensee;
 
  •  $500,000 upon initiation of the first Phase II clinical trial for each compound in each of the three territories covered by the license;
 
  •  $1.0 million for the first NDA filing or comparable foreign regulatory filing for each compound in each of these three territories; and
 
  •  royalty payments ranging from 2.1% to 6.5% of net sales of products covered by patents licensed to us by Sucampo AG.
 
  •  Our share of research and development costs for AMITIZA. As of March 31, 2007, we had incurred $11.0 million of these costs. We expect to incur $2.0 million of additional costs in connection with the development of AMITIZA for the treatment of irritable bowel syndrome with constipation and expect to incur approximately $2.0 million of additional costs in connection with the development of AMITIZA for other indications, such as the treatment of opioid-induced bowel dysfunction, which will not be reimbursed by Takeda.
 
  •  Expenses under agreements with contract research organizations for clinical trials of our product candidates. The timing and amount of these disbursements are based on a variety of factors, such as the achievement of specified milestones, patient enrollment, services rendered or the incurrence of expenses by the contract research organization. As a result, we must reasonably estimate the potential timing and amount of these payments. We estimate our current commitments to contract research organizations at March 31, 2007 to be $2.6 million for the nine months ending December 31, 2007.
 
In addition, the FDA has required us to perform two post-marketing studies to evaluate the safety of AMITIZA in patients with renal impairment and patients with hepatic impairment. Under our collaboration agreement with Takeda, the costs for these studies will be shared 70% by Takeda and 30% by us. We do not anticipate our portion of these expenses will exceed $5.0 million.


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Funding Requirements
 
In addition to our normal operating expenses, we estimate that our specific funding requirements through the first half of 2008 will include:
 
  •  Up to $1.0 million to fund our 30% share of the two post-marketing studies of AMITIZA to evaluate its safety in patients with renal impairment and patients with hepatic impairment. We initiated these studies in January 2007.
 
  •  Approximately $18.0 million to fund development and regulatory activities for SPI-8811 and SPI-017, which we expect will enable us to substantially complete at least the following development efforts:
 
  •  a Phase II clinical trial of SPI-8811 for the prevention and treatment of NSAID-induced ulcers, which we plan to commence in the third quarter of 2007;
 
  •  a Phase II proof-of-concept study of SPI-8811 in patients with portal hypertension, which we plan to commence in 2007;
 
  •  a Phase II clinical trial of SPI-8811 in patients with cystic fibrosis, which we plan to commence by the second quarter of 2008; and
 
  •  Phase I clinical trials of an intravenous formulation of SPI-017 for peripheral arterial and vascular disease and stroke, which we plan to commence in 2008;
 
  •  Up to $12.0 million to fund the expansion of our commercialization activities in the United States and the initiation of commercialization efforts in non-U.S. markets;
 
  •  Up to $1.0 million to fund regulatory efforts by Sucampo Europe and Sucampo Japan for AMITIZA and SPI-8811;
 
  •  Up to $6.0 million for research and development activities for prostone compounds other than AMITIZA, SPI-8811 and SPI-017;
 
  •  Up to $1.0 million to fund costs in connection with computers, software and information technology to support growth in our business.
 
Takeda will fund 100% of the Phase IV clinical trials of AMITIZA for the treatment of chronic idiopathic constipation in pediatric patients that we initiated in January 2007.
 
We believe that the net proceeds from this offering, together with our existing cash and cash equivalents and internally generated funds from AMITIZA product sales, will be sufficient to enable us to fund our operating expenses for the foreseeable future. We have based this estimate on assumptions that may prove to be wrong. There are numerous risks and uncertainties associated with AMITIZA product sales and with the development and commercialization of our product candidates. Our future capital requirements will depend on many factors, including:
 
  •  the level of AMITIZA product sales;
 
  •  the scope, progress, results and costs of preclinical development and laboratory testing and clinical trials for our product candidates;
 
  •  the costs, timing and outcome of regulatory review of our product candidates;
 
  •  the number and development requirements of other product candidates that we pursue;
 
  •  the costs of commercialization activities, including product marketing, sales and distribution;
 
  •  the costs of preparing, filing and prosecuting patent applications and maintaining, enforcing and defending intellectual property-related claims;
 
  •  the extent to which we acquire or invest in businesses, products and technologies; 
 
  •  our ability to establish and maintain collaborations, such as our collaboration with Takeda; and


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  •  changes in our business plan as a result of changes in the market conditions resulting from withdrawal or approval of competing products, such as recently occurred when Novartis withdrew Zelnorm from the U.S. market.
 
In particular, we could require external sources of funds for acquisitions that we determine to make in the future.
 
To the extent that our capital resources are insufficient to meet our future capital requirements, we will need to finance our future cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements. Except for development funding by Takeda, we do not currently have any commitments for future external funding.
 
Additional equity or debt financing, grants or corporate collaboration and licensing arrangements may not be available on acceptable terms, if at all. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate our research and development programs, reduce our planned commercialization efforts or obtain funds through arrangements with collaborators or others that may require us to relinquish rights to certain product candidates that we might otherwise seek to develop or commercialize independently. In addition, any future equity funding may dilute the ownership of our equity investors.
 
Related Party Transactions
 
Under our license agreement with our affiliate Sucampo AG, we are required to make specified milestone and royalty payments. We estimated the fair value of this arrangement based upon like-kind third-party evidentiary matter for the transaction. When we entered into this agreement, we performed an economic analysis of the transaction to ensure that we were receiving a return on our investment equivalent to that of other pharmaceutical companies. In addition, we performed a transfer pricing study and economic analysis to provide evidence that the agreement did not conflict with taxing guidelines.
 
Under our exclusive supply agreement with R-Tech, R-Tech made milestone payments to us totaling $6.0 million during 2004 and we recorded the full amount as deferred revenue. We first began to recognize these payments as revenue during the quarter ended June 30, 2006 and will continue to recognize them ratably through 2020. When we entered into this agreement, we evaluated the net present value of the supply agreement, based upon anticipated cash flows from the successful development and commercialization of the compounds it covers, to determine the current value of the transaction. Additionally, we performed a transfer pricing study and economic analysis to provide evidence the agreement did not conflict with taxing guidelines.
 
For information regarding additional related party transactions, see notes 8 and 9 to our consolidated financial statements appearing at the end of this prospectus.
 
Changes in the application of domestic or foreign taxing regulations and interpretation of related party transactions with foreign entities could affect the extent to which taxing authorities agree that these transactions are on an arm’s length basis.
 
Quantitative and Qualitative Disclosures About Market Risk
 
Our exposure to market risk is currently confined to our cash and cash equivalents and investments in auction-rate securities. We currently do not hedge interest rate exposure. We have not used derivative financial instruments for speculative or trading purposes. Because of the short-term maturities of our cash and cash equivalents, we do not believe that an increase in market rates would have any significant impact on the realized value of our investments.
 
Effects of Inflation
 
Our most liquid assets are cash, cash equivalents and short-term investments. Because of their liquidity, these assets are not directly affected by inflation. We also believe that we have intangible assets in the value of our intellectual property. In accordance with generally accepted accounting principles, we have not capitalized the value of this intellectual property on our balance sheets. Due to the nature of this intellectual property, we believe that these intangible assets are not affected by inflation. Because we intend to retain and continue to


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use our equipment, furniture and fixtures and leasehold improvements, we believe that the incremental inflation related to replacement costs of such items will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and contract services, which could increase our level of expenses and the rate at which we use our resources.
 
Effects of Foreign Currency
 
We currently incur a portion of our operating expenses in the United Kingdom and Japan. The reporting currency for our consolidated financial statements is U.S. Dollars. As such, our results of operations could be adversely effected by changes in exchange rates either due to transaction losses, which are recognized in the statement of operations, or translation losses, which are recognized in comprehensive income. We currently do not hedge foreign exchange rate exposure.
 
Off Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities.
 
Accounting Pronouncements
 
In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS 123R, which requires companies to expense the estimated fair value of employee stock options and similar awards. SFAS 123R replaces SFAS 123 and supersedes APB 25. In March 2005, the Securities and Exchange Commission, or SEC, issued SAB Bulletin No. 107, “Share-Based Payments”, or SAB 107, which generally provides the SEC staff’s views regarding SFAS 123R. SAB 107 provides guidance on how to determine the expected volatility and expected term inputs into a valuation model used to determine the fair value of share-based payments. SAB 107 also provides guidance related to numerous aspects of the adoption of SFAS 123R such as income taxes, capitalization of compensation costs, modification of share-based payments prior to adoption and the classification of expenses. We have applied the principles of SAB 107 in conjunction with our adoption of SFAS 123R.
 
As of January 1, 2006, we adopted the provisions of SFAS 123R using a prospective transition method. There was no impact to our consolidated financial statements as a result of this adoption as of January 1, 2006. Under the prospective transition method, SFAS 123R, which provides changes to the methodology for valuing share-based compensation among other changes, will apply to new awards and to awards outstanding on the effective date that are subsequently modified or cancelled.
 
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3”, or SFAS 154. This statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement also requires that a change in depreciation, amortization or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 as of January 1, 2006 did not have a material effect on our consolidated financial statements.
 
In November 2005, the FASB Staff issued FASB Staff Position, or FSP, FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, or FSP FAS 115-1. FSP FAS 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends FASB Statements No. 115, “Accounting for Certain Investments in Debt and


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Equity Securities”, and No. 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations”, and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”. The guidance in this FSP must be applied to reporting periods beginning after December 15, 2005. The adoption of FSP FAS 115-1 as of January 1, 2006 did not have a material effect on our consolidated financial statements.
 
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, or FIN 48, which is effective as of the interim reporting period beginning January 1, 2007. The validity of any tax position is a matter of tax law, and generally there is no controversy about recognizing the benefit of a tax position in a company’s financial statements when the degree of confidence is high that the tax position will be sustained upon examination by a taxing authority. The tax law is subject to varied interpretation, however, and whether a tax position will ultimately be sustained may be uncertain. Under FIN 48, the impact of an uncertain income tax position on the income tax provision must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. FIN 48 also requires additional disclosures about unrecognized tax benefits associated with uncertain income tax positions and a reconciliation of the change in the unrecognized benefit. In addition, FIN 48 requires interest to be recognized on the full amount of deferred benefits for uncertain tax positions. An income tax penalty is recognized as expense when the tax position does not meet the minimum statutory threshold to avoid the imposition of a penalty. The adoption of FIN 48 as of January 1, 2007 did not have an impact on our consolidated financial statements.
 
In September 2006, the FASB Staff issued FASB Statement No. 157, “Fair Value Measurements”, or SFAS 157, which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. The FASB believes that the new standard will make the measurement of fair value more consistent and comparable and improve disclosures about those measures. We will be required to adopt SFAS 157 for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are assessing SFAS 157, but we currently do not believe it will have a material impact on our consolidated financial statements.
 
In September 2006, the SEC Staff issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, or SAB 108. SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current year’s financial statements are materially misstated. SAB 108 will be effective for our consolidated financial statements in the fourth quarter of 2006. We evaluated the requirements of SAB 108 and concluded that its adoption did not have a material effect on our consolidated financial statements.
 
In February 2007, the FASB Staff issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, or SFAS 159, which provides entities with the opportunity to measure certain financial instruments at fair value. We will be required to adopt SFAS 159 for the year beginning January 1, 2008. We do not believe SFAS 159 will have a material impact on our future consolidated financial statements.
 
Internal Control Over Financial Reporting
 
In connection with the acquisition of Sucampo Europe and Sucampo Japan and our preparation of audited financial information for those two entities for the year ended December 31, 2005, we identified control deficiencies relative to those entities that constitute material weaknesses in the design and operation of our internal control over financial reporting.
 
In general, a material weakness is defined as a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of annual or interim financial statements will not be prevented or detected. The material weaknesses we identified are as follows:
 
  •  We did not maintain effective controls over the completeness and accuracy of revenue recognition. Specifically, effective controls were not designed and in place to adequately review contracts for the


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  accuracy and proper cut-off of revenue recognition at Sucampo Europe and Sucampo Japan. This control deficiency resulted in adjustments to the revenue and deferred revenue accounts. Additionally, this control deficiency could result in a misstatement of the revenue and deferred revenue accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
  •  We did not maintain effective controls over the completeness and accuracy of the accounting for debt instruments. Specifically, effective controls were not designed and in place to adequately review debt agreements of Sucampo Europe and Sucampo Japan for the proper accounting implications, or to ensure appropriate communication within our company regarding the existence of all debt agreements. This control deficiency resulted in adjustments to accounts payable, other liabilities and notes payable accounts. Additionally, this control deficiency could result in a misstatement of accounts payable, other liabilities and notes payable accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
  •  We did not maintain effective controls over the preparation, review and presentation of the financial information prepared in accordance with U.S. generally accepted accounting principles reflecting Sucampo Europe and Sucampo Japan operations. Specifically, effective controls were not designed and in place to adequately review, analyze and monitor these affiliates’ financial information, nor did we have a standard reporting format for these affiliates, accounting procedures and policies manuals, formally documented controls and procedures or a formal process to review and analyze financial information of these affiliates. This control deficiency resulted in adjustments to revenue, deferred revenue, accounts payable, accrued expenses, other liabilities and notes payable accounts, as well as the statement of cash flows. Additionally, this control deficiency could result in a misstatement in a number of our financial statement accounts, including the statement of cash flows, resulting in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
Sucampo Europe and Sucampo Japan collectively accounted for 2.7% of our total revenues in the year ended December 31, 2006 and 0.1% of our total revenues for the three months ended March 31, 2007.
 
In connection with the restatement of our consolidated financial statements as of and for the year ended December 31, 2005 for errors in our deferred tax assets and our accounting for fully vested options granted, we identified additional control deficiencies that constitute material weaknesses in the design and operation of our internal controls over financial reporting. In particular:
 
  •  We did not maintain effective controls over the completeness, accuracy and valuation of accounting for certain income tax balances. Specifically, effective controls were not designed and in place to periodically assess, at an appropriate level of detail, the “more likely than not” criteria for recognition of deferred tax assets. This control deficiency resulted in adjustments to the deferred tax asset valuation allowance and the income tax provision accounts, which resulted in a restatement of our consolidated financial statements as of and for the year ended December 31, 2005 and for the three months ended March 31, 2006. Additionally, this control deficiency could result in a misstatement of the deferred tax asset valuation allowance and income tax provision accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
  •  We did not maintain effective controls over the valuation and accuracy of accounting for non-employee stock options. Specifically, effective controls were not designed and in place to value the options using the contractual term as opposed to an expected term. This control deficiency resulted in adjustments to the research and development expenses and additional paid-in capital accounts and resulted in a restatement of our financial statements as of and for the year ended December 31, 2005. Additionally, this control deficiency could result in a misstatement of operating expenses and additional paid-in capital accounts that would result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.
 
We have taken steps to remediate the material weaknesses in the areas of maintaining effective controls over the completeness and accuracy of revenue recognition and accounting for debt instruments at Sucampo


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Europe and Sucampo Japan, the completeness, accuracy and valuation of accounting for income tax balances, and the valuation and accuracy of accounting for non-employee stock options, including the implementation of the following controls and processes:
 
  •  transferring the authority to execute agreements and incur indebtedness from Sucampo Europe and Sucampo Japan to our headquarters;
 
  •  establishing and implementing formal processes for analyzing and approving accounting for contracts and debt agreements;
 
  •  establishing formal controls for review of the accuracy and proper cut-off of revenue recognition and accrued expenses at Sucampo Europe and Sucampo Japan to be completed at our headquarters;
 
  •  hiring a third-party tax consultant to assist in our calculation and evaluation of our annual and interim income tax accounting, including the deferred tax asset valuation allowance and provision accounts; and
 
  •  hiring a third-party specialist to assist in the calculation of the fair value of all non-employee equity awards granted.
 
We have not yet fully remediated the material weaknesses in the area of effective controls over the preparation, review and presentation of financial information prepared in accordance with U.S. generally accepted accounting principles reflecting Sucampo Europe’s and Sucampo Japan’s operations. If we are unable to remediate this material weakness, 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 of 1934, or the Exchange Act, upon the completion of this offering will intensify the need for us to report our financial position, results of operations and cash flows on an accurate and timely basis.
 
We have concluded that the control deficiency that resulted in the restatement of the consolidated financial statements for the years ended December 31, 2004 and 2005 as a result of the revenue recognition error did not constitute a material weakness because management determined that there were controls designed and in place to prevent or detect a material misstatement and, therefore, the likelihood of revenue being materially misstated is not more than remote.
 
The process of improving our internal controls has required and will continue to require us to expend significant resources to design, implement and maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. There can be no assurance that any actions we take will be successful. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an on-going basis.


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BUSINESS
 
Overview
 
We are an emerging pharmaceutical 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. The therapeutic potential of prostones was first identified by one of our founders, Dr. Ryuji Ueno. We believe that most prostones function as activators of cellular ion channels and, as a result, may be effective at promoting fluid secretion and enhancing cell protection, which may give them wide-ranging therapeutic potential, particularly for age-related diseases. We are focused on developing prostones with novel mechanisms of action for the treatment of gastrointestinal, respiratory, vascular and central nervous system diseases and disorders for which there are unmet or underserved medical needs and significant commercial potential.
 
In January 2006, we received marketing approval from the U.S. Food and Drug Administration, or FDA, for our first product, AMITIZA® (lubiprostone), 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, including those over 65 years of age, and that has demonstrated 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 an additional study published in The American Journal of Gastroenterology, 91% of physicians expressed a desire for better treatment options for constipation.
 
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.
 
We are party to 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, opioid-induced bowel dysfunction and other gastrointestinal indications in the United States and Canada. We have the right to co-promote AMITIZA along with Takeda in these markets. We and Takeda initiated commercial sales of AMITIZA in the United States for the treatment of chronic idiopathic constipation in April 2006. Takeda is marketing AMITIZA broadly to office-based specialty physicians and primary care physicians. We are complementing 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 will be a key market for AMITIZA to treat gastrointestinal indications, and by physicians who are key opinion leaders in the gastrointestinal field. We have performed all of the development activities with respect to AMITIZA and Takeda has funded a portion of the cost for these activities. We have retained the rights to develop and commercialize AMITIZA outside the United States and Canada and to develop and commercialize it in the United States and Canada for indications other than gastrointestinal indications.
 
We also plan to pursue marketing approval for AMITIZA for additional constipation-related gastrointestinal indications with large, underserved markets. We recently completed two pivotal Phase III clinical trials and a long-term safety trial of AMITIZA for the treatment of irritable bowel syndrome with constipation. In these trials, AMITIZA improved overall relief from symptoms associated with irritable bowel syndrome with constipation with statistical significance and was well tolerated. Based upon the results of these trials, we submitted a supplement to our existing new drug application, or NDA, for AMITIZA to the FDA in June 2007 seeking marketing approval for AMITIZA for the treatment of this indication. In addition, we plan to commence Phase III pivotal clinical trials of AMITIZA for the treatment of opioid-induced bowel dysfunction


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in the third quarter of 2007. According to the American College of Gastroenterology, irritable bowel syndrome affects approximately 58 million people in the United States, with irritable bowel syndrome with constipation accounting for approximately one-third of these cases. We also plan to pursue 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 addition, we are developing other prostone compounds for the treatment of a broad range of diseases. The most advanced of these programs are:
 
  •  SPI-8811 (cobiprostone) for the treatment of ulcers induced by non-steroidal anti-inflammatory drugs, or NSAIDs, portal hypertension, non-alcoholic fatty liver disease, disorders associated with cystic fibrosis and chronic obstructive pulmonary disease. We have completed Phase I clinical trials of SPI-8811 in healthy volunteers and plan to commence a Phase II clinical trial of this product candidate for the treatment of NSAID-induced ulcers in the third quarter of 2007. We also plan to commence a Phase II proof-of-concept study of SPI-8811 in patients with portal hypertension in 2007.
 
  •  SPI-017 for the treatment of peripheral arterial and vascular disease and 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. We also are developing an oral formulation of SPI-017 for the treatment of Alzheimer’s disease. We plan to commence Phase I clinical trials of the intravenous formulation of SPI-017 and Phase I clinical trials of the oral formulation in 2008.
 
We hold an exclusive worldwide royalty-bearing license from Sucampo AG, a Swiss patent-holding company, to develop and commercialize AMITIZA and other prostone compounds covered by patents and patent applications held by Sucampo AG. 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. If we have not committed specified development efforts to any prostone compound other than AMITIZA, SPI-8811 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. Kuno and Ueno 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, a Japanese pharmaceutical manufacturer, to provide us with clinical and commercial supplies of AMITIZA and clinical supplies of our product candidates SPI-8811 and SPI-017. These arrangements include provisions requiring R-Tech 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. 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. Kuno and Ueno are considering plans to reduce their equity ownership in R-Tech.


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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.
 
             
Product/ Product
           
Candidate   Target Indication   Development Phase   Next Milestone
 
AMITIZA   Chronic idiopathic constipation (adult)   Marketed  
             
    Chronic idiopathic constipation (pediatric)   Phase IV pediatric trial ongoing  
             
    Irritable bowel syndrome with constipation   Supplemental NDA filed   FDA marketing approval
             
    Opioid-induced bowel dysfunction   Planning Phase III pivotal trial   Phase III pivotal trial planned to commence in the third quarter of 2007
 
 
             
SPI-8811
  Gastrointestinal        
             
      Non-steroidal anti-   Phase I testing   Phase II trial planned
      inflammatory drug   completed   to commence in the third
      (NSAID) induced ulcers       quarter of 2007
             
      Cystic fibrosis —
  gastrointestinal disorders
  (oral formulation)
  Phase II trial completed   Phase II dose-ranging trial planned to commence in 2008
             
    Liver        
      Portal hypertension   Preclinical testing completed   Phase II proof-of-concept study planned to commence in 2007
             
      Non-alcoholic fatty liver
  disease
  Phase II trial completed   Pending availability of new diagnostic tool
             
    Pulmonary        
      Cystic fibrosis — respiratory
  symptoms (inhaled
  formulation)
  Preclinical  

Finalize inhaled formulation
             
      Chronic obstructive
  pulmonary disease
  Preclinical    
 
 
             
SPI-017
 
Peripheral arterial and vascular disease


Stroke
 
Preclinical


Preclinical
 
Phase I trials of intravenous formulation planned to commence in 2008*
             
    Alzheimer’s disease   Preclinical   Phase I trials of oral formulation planned to commence in 2008*
   
* Results from Phase I trials of both intravenous and oral formulations may be useful in development of any of these indications.
 
 
 
Scientific Background of Prostones
 
Prostones are a class of compounds derived from functional fatty acids that occur naturally in the human body. The therapeutic potential of prostones was first identified by Dr. Ueno. Fatty acids serve as fuel for energy production in cells in many organisms and are intermediates in the synthesis of other important


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chemical compounds. To date, two prostone products have received marketing approval: AMITIZA for the treatment of chronic idiopathic constipation and RESCULA® (unoprostone isopropyl) for the treatment of glaucoma. RESCULA, which was developed by R-Tech under the leadership of Drs. Ueno and Kuno, was the first commercially available prostone drug. RESCULA was first sold in Japan beginning in 1994 and is currently marketed in more than 40 countries worldwide. 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.
 
Ion Channel Activation
 
Based on our preclinical and clinical 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. The concentration of specific ions within particular types of cells is important to many vital physiological functions in the human body. Because ions cannot move freely across cell membranes, they must enter or exit a cell 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. Each kind of ion moves through its own specific ion channel. Some molecular compounds, including 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, SPI-8811 and SPI-017, all three compounds selectively 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 cellular voltage 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 method of action of prostones that serve as selective ion channel activators may result in the following beneficial effects:
 
  •  Enhancement of Fluid Secretion.  Activating the movement of specific ions into and out of cells can promote the secretion of fluid into neighboring areas. For example, AMITIZA promotes fluid secretion into the small intestine by activating the ClC-2 channel in the cells lining the small intestine. Likewise, RESCULA is a potassium channel activator that works to treat glaucoma by increasing aqueous humor outflow in ocular cells in the eyes.
 
  •  Recovery of Barrier Function.  Disruption of the barrier function in human cells can trigger cell damage by increasing the permeability of cells and tissue, thereby diminishing the body’s first line of defense. Recently, protein complexes occurring between cells known as “tight junctions” have been found to play a critical role in the regulation of barrier function in the body. The ClC-2 channel plays an important role in the restoration of these tight junction complexes and in the recovery of barrier function in the body. In preclinical studies, AMITIZA appeared to accelerate the recovery of the disrupted barrier function through the restoration of the tight junction structure. We believe that this may be a result of AMITIZA’s specific effects on the ClC-2 channel. We believe that other prostones that act as ClC-2 channel activators may have a similar barrier recovery function.
 
  •  Localized Activity.  Because most prostones act through contact with cells, their pharmacological activity is localized in those areas where the compound is physically present in its active form. Because some prostones metabolize relatively quickly to an inactive form, we believe their pharmacological effects are not spread to other parts of the body. These properties allow some prostones to be targeted


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  to specific types of cells in specific organs through different routes of administration. For example, when AMITIZA is taken orally, it arrives in the small intestine and liver while it is still active and begins to act on the cells lining those organs. By the time it is passed through to the large intestine, it appears to have been largely metabolized and is no longer active. Similarly, we believe that inhaled formulations of some prostones would act principally in the lungs and intravenous formulations would act principally in the vascular system, in each case without having systemic effects.
 
Our Strategy
 
Our goal is to become a leading pharmaceutical company focused on discovering, developing and commercializing proprietary drugs based on prostones to treat diseases and disorders for which there are unmet or underserved medical needs and significant commercial potential. Our strategy to achieve this objective includes the following key elements:
 
Focus on commercial sales of AMITIZA in the United States for the treatment of chronic idiopathic constipation in adults.  We initiated commercial sales of AMITIZA in the United States for the treatment of chronic idiopathic constipation in collaboration with Takeda in April 2006. Takeda is marketing AMITIZA broadly to office-based specialty physicians and primary care physicians. Pursuant to the terms of our collaboration and license agreement with Takeda, Takeda is obligated to provide a dedicated sales force of at least 200 people to promote AMITIZA and a supplemental sales force of at least 500 people to promote AMITIZA together with one other drug product, although Takeda has advised us that their supplemental sales force currently consists of over 700 people. We are complementing Takeda’s marketing efforts by promoting AMITIZA in the institutional marketplace through a specialty sales force consisting of 38 field sales representatives. This institutional market is characterized by a concentration of elderly patients, who we believe will be a key market for AMITIZA to treat gastrointestinal indications, and by physicians who are key opinion leaders in the gastrointestinal field. In connection with the commercial launch of AMITIZA, we have recruited experienced internal sales and marketing leadership and developed a marketing strategy and promotional materials for the commercialization of AMITIZA in our targeted institutional market.
 
Develop AMITIZA for the treatment of additional indications and discover, develop and commercialize other prostone product candidates.  We are concentrating our development efforts on expanding the approved indications for AMITIZA and developing our product candidates SPI-8811 and SPI-017. We hold an exclusive worldwide royalty-bearing license from Sucampo AG to develop and commercialize each of these prostone compounds. In the future, we also expect to develop other proprietary prostones. We believe that our focus on prostones may offer several potential advantages, including:
 
  •  Novel mechanisms of action.  We believe that AMITIZA, SPI-8811 and SPI-017 have, and that additional product candidates that we may develop in the future based on prostones may have, novel mechanisms of action, such as selective ClC-2 chloride channel activation, that offer physicians a new approach to treatment of targeted indications.
 
  •  Wide-ranging therapeutic potential of prostones.  We believe that many prostones promote fluid secretion, enhance cell barrier protection and can be developed to target particular organs or systems of the body. As a result, we believe that we will be able to develop prostone drugs to treat multiple diseases and disorders of the gastrointestinal, respiratory, vascular and central nervous systems.
 
  •  Our discovery and development experience with prostones.  We expect that our considerable experience with AMITIZA, as well as the knowledge gained by Drs. Ueno and Kuno in the development of RESCULA, will facilitate our discovery and clinical development of additional prostone compounds.
 
  •  Patent protection.  AMITIZA, SPI-8811 and SPI-017 each are covered by composition-of-matter, method of use and other issued patents or patent applications in the United States, Europe and Japan.
 
Target large and underserved markets, with a particular focus on treating indications in the elderly population.  We believe that drugs based on prostones may be able to address a variety of large markets characterized either by treatments with limited effectiveness or, in some cases, no treatment. In addition to


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AMITIZA for the treatment of chronic idiopathic constipation in adults, the indication for which it has been approved by the FDA, we are targeting:
 
  •  AMITIZA for the treatment of chronic idiopathic constipation in pediatric patients and for the treatment of irritable bowel syndrome with constipation and opioid-induced bowel dysfunction;
 
  •  SPI-8811 for the treatment of NSAID-induced ulcers, portal hypertension, non-alcoholic fatty liver disease, disorders associated with cystic fibrosis and chronic obstructive pulmonary disease; and
 
  •  SPI-017 for the treatment of peripheral arterial disease, stroke and Alzheimer’s disease.
 
Seek marketing approval for AMITIZA and our other product candidates outside the United States.  We plan to pursue marketing approval for AMITIZA and our other product candidates in markets outside the United States, including Europe, the Asia Pacific region and Latin America. To the extent possible, we intend to use the data from our U.S. clinical trials and the experience gained from the U.S. approval process to expedite the approval process in other countries. If we receive marketing approval for our products outside the United States, we plan to retain co-commercialization rights and work with third-party pharmaceutical companies with marketing, sales and distribution capabilities in the relevant regions to commercialize these products.
 
Focus on our core discovery and clinical development and commercialization activities.  Our business model is to devote our resources and efforts to discovering, developing and commercializing product candidates based on prostones, while outsourcing other, non-core business functions to third parties. Following this approach, we selectively collaborate with a number of third parties to assist us with these non-core business functions. These collaborators include:
 
  •  Our affiliate R-Tech, which manufacturers commercial and clinical supplies of AMITIZA and other prostone compounds for us;
 
  •  Takeda, with whom we are collaborating to market AMITIZA for the treatment of chronic idiopathic constipation in adults and other gastrointestinal indications in the United States and Canada; and
 
  •  Contract research organizations, whom we engage to perform preclinical and clinical trials of our product candidates.
 
We believe that applying our resources in this way allows us to concentrate on our core strengths while benefiting from the specialized expertise of our third-party collaborators. In addition, we may decide to outsource clinical development activities for some of the compounds and indications in our product pipeline if we determine it would be more cost-effective to do so. For example, we may conclude that it is more economical to license SPI-8811 for pulmonary indications, such as respiratory symptoms of cystic fibrosis and chronic obstructive pulmonary disease, to a third party who would conduct the necessary clinical development activities in support of those indications.
 
Grow through strategic acquisitions and in-licensing opportunities.  We intend to pursue strategic acquisitions and in-licensing opportunities to complement our existing product pipeline. We have a specialty sales and marketing function focused on the institutional market and we have significant experience in pharmaceutical research and product development, including clinical trials and regulatory affairs. We believe that the institutional focus of our specialty sales force would facilitate our ability to sell additional products targeted at a variety of indications in several therapeutic fields that are concentrated in the institutional setting. This institutional market is characterized by a concentration of elderly patients. We believe that these capabilities will help us to identify attractive acquisition, in-licensing and co-promotion opportunities to build upon our core clinical development and commercialization capabilities.


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Products and Product Candidates
 
AMITIZA® (lubiprostone)
 
     Overview
 
We are developing AMITIZA for the treatment of multiple constipation-related gastrointestinal disorders. AMITIZA functions as a selective 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, after a 10-month review, the FDA approved our new drug application, or NDA, for AMITIZA for the treatment of chronic idiopathic constipation in adults of both genders and all ages, including those over 65 years of age, 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 MiraLaxtm (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 recently approved 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 fail to respond to laxatives, Zelnorm® (tegaserod maleate), a partial serotonin-receptor agonist, was often prescribed. In March 2007, at the request of the FDA, Zelnorm was withdrawn from the U.S. market by Novartis. The FDA requested that Novartis discontinue marketing Zelnorm based on a recently identified finding of an increased risk of serious cardiovascular adverse events associated with use of the drug. The FDA indicated that it might allow Zelnorm to be prescribed under a special program to some patients for whom no other treatment options are available and in whom the benefits of Zelnorm treatment outweigh the chance of serious side effects. The FDA also indicated a willingness to consider limited re-introduction of Zelnorm in the United States if a population of patients can be identified in whom the benefits of the drug outweigh the risks, following discussion at a public advisory committee meeting. Even before its withdrawal, however, Zelnorm was not approved for administration to patients over 65 years of age and has been linked with incidents of ischemic colitis, a life-threatening inflammation of the large intestine caused by


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restricted blood flow, and other forms of intestinal ischemia. In addition, the effectiveness of Zelnorm for the treatment of chronic idiopathic constipation has not been studied beyond 12 weeks.
 
Market Opportunity.  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 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:
 
  •  AMITIZA has been approved for administration to adults of all ages, including those over 65 years of age;
 
  •  AMITIZA has been approved without limitation on duration of use; and
 
  •  AMITIZA has not been associated with the serious side effects observed with some other treatment options, such as ischemic colitis, electrolyte imbalance and cardiovascular ischemic events.
 
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 III 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 III 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.


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The table below sets forth the mean number of spontaneous bowel movements for the intent-to-treat population in these two pivotal trials on a weekly basis for each of the four weeks of the trials. The intent-to-treat population for these trials consisted of all participants enrolled in the trials who were randomized and received at least one dose of AMITIZA or placebo with the last observation carried forward.
 
AMITIZA for Chronic Idiopathic Constipation
Pivotal Phase III Clinical Trial Results
Weekly Number of
Spontaneous Bowel Movements
(SPONTANEOUS BOWEL MOVEMENTS CHART)
 
In the table above, “n” indicates the number of participants in each treatment group.
 
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.


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Safety Profile and Withdrawal Effects.  AMITIZA was well tolerated in twice-daily doses of 24 micrograms each in an earlier Phase II trial, the two Phase III 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, in patients with renal impairment and in patients with hepatic impairment. We initiated the studies in January 2007.
 
     Irritable Bowel Syndrome with Constipation
 
We have conducted two Phase III pivotal trials and a long-term safety trial of AMITIZA in men and women for the treatment of irritable bowel syndrome with constipation. In these trials, participants took AMITIZA gelatin capsules orally in twice daily 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 is currently the only FDA-approved drug indicated for the treatment of irritable bowel syndrome with constipation, although its label limits its indication to short-term treatment of women. In March 2007, however, at the request of the FDA, Zelnorm was withdrawn from the U.S. market by Novartis. The FDA requested that Novartis discontinue marketing Zelnorm based on a recently identified finding of an increased risk of serious cardiovascular adverse events associated with use of the drug. The FDA indicated that it might allow Zelnorm to be prescribed under a special program to some patients for whom no other treatment options are available and in whom the benefits of Zelnorm treatment outweigh the chance of serious side effects. The FDA also indicated a willingness to consider limited re-introduction of Zelnorm in the United States if a population of patients can be identified in whom the benefits of the drug outweigh the risks, following discussion at a public advisory committee meeting. In December 2005, the European Medicines Agency refused 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 II 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


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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 III 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.
 
In accordance with the trial’s protocol, we conducted comparisons of specific doses of AMITIZA versus placebo to evaluate differences in patient’s assessments of abdominal discomfort and pain before and after treatment. During the first month of treatment, only the 48 microgram dose demonstrated a statistically significant improvement over placebo in mean change from baseline, showing an improvement of 0.46 points for AMITIZA compared to an improvement of 0.19 for the placebo, and with a p-value of 0.0226. During the second month of treatment, improvements from baseline in all three doses were statistically significant compared with placebo, with improvements of 0.52 points at the 16 microgram dose of AMITIZA, 0.53 points at the 32 microgram dose and 0.54 points at the 48 microgram dose, compared to a 0.23 point improvement for the placebo, with p-values of 0.0392 for the 16 microgram dose, 0.0331 for the 32 microgram dose and 0.0277 for the 48 microgram dose. The mean change from baseline compared with placebo in the 32 microgram dose during the first month of treatment was not statistically significant. Accordingly, as provided in the trial protocol, we initially did not test the 16 microgram dose compared to placebo for the first month of treatment. However, we subsequently performed a comparison that demonstrated a statistically significant improvement from baseline abdominal discomfort and pain in the 16 microgram dose during the first month of treatment compared with placebo, with an improvement of 0.45 points for AMITIZA compared to 0.19 points for placebo, and with a p-value of 0.033. 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 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. Nausea was reported by 17% of participants dosed at 16 micrograms and 22% of participants dosed at 48 micrograms, and diarrhea was reported by 12% of participants dosed at 16 micrograms and 27% of participants dosed at 48 micrograms.
 
Based on the results of this Phase II trial, we initiated two pivotal Phase III 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. We enrolled the last participant for these trials in April 2006. These Phase III 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


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with constipation. The secondary efficacy endpoints were similar to those for our Phase II 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 safety study to assess the long-term use of AMITIZA as a treatment for this indication.
 
In the two pivotal phase III 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 III 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.
 
AMITIZA was well-tolerated in the phase II and the phase III trials. In those studies combined 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.
 
Based on these trial results, we submitted a supplement to our existing new drug application, or NDA, for AMITIZA to the FDA in June 2007 seeking marketing approval for AMITIZA for the treatment of this indication.
 
     Opioid-Induced Bowel Dysfunction
 
We plan to commence Phase III pivotal clinical trials of orally administered AMITIZA gelatin capsules for the treatment of opioid-induced bowel dysfunction in the third quarter of 2007.
 
Disease Overview.  Opioid-induced bowel dysfunction comprises a variety of gastrointestinal side effects stemming from the use of narcotic medications such as morphine and codeine, which are referred to as opioids. Physicians prescribe opioids for patients with advanced medical 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 effects that lead to opioid-induced constipation, including inhibition of large intestine motility, decreased gastric emptying and hard stools.


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Current Treatment.  There are currently no FDA-approved 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. As a result, patients frequently must discontinue opioid therapy and endure pain in order to obtain relief from opioid-induced bowel dysfunction.
 
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. In these studies, 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 have determined to pursue development of AMITIZA as a treatment for opioid-induced bowel dysfunction.
 
SPI-8811 (cobiprostone)
 
     Overview
 
We are developing the prostone compound SPI-8811 for oral administration to treat various gastrointestinal and liver disorders, including NSAID-induced ulcers, non-alcoholic fatty liver disease, portal hypertension and gastrointestinal disorders associated with cystic fibrosis. We also plan to develop an inhaled formulation of SPI-8811 for the treatment of respiratory symptoms of cystic fibrosis and chronic obstructive pulmonary disease. We believe that SPI-8811, 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 completed two Phase I clinical trials of SPI-8811 in healthy volunteers in Japan in 1997. In these trials, orally administered SPI-8811 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 SPI-8811.
 
     Non-Steroidal Anti-Inflammatory Drug-Induced Ulcers
 
We plan to commence a Phase II clinical trial of SPI-8811 for the prevention and treatment of NSAID-induced ulcers in the third quarter of 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


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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 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 SPI-8811’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 SPI-8811 as a potential therapy for NSAID-induced ulcers. In preclinical tests in rats, SPI-8811 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 plan to commence a Phase II clinical trial for SPI-8811. We expect that this Phase II trial will be a multi-center, randomized, placebo-controlled study to evaluate the effects of multiple doses of SPI-8811 for the treatment and prevention of ulcer formation following treatment with NSAIDs. We believe that SPI-8811 may have utility in preventing other gastric injury in addition to NSAID-induced ulcers. Accordingly, as we progress through our clinical program for SPI-8811, 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. According to a physician survey conducted by MEDACorp, an independent strategic consulting firm focused on the health care sector and a division of Leerink Swann & Co., Inc., one of the managing underwriters for this offering, approximately 4.0 million Americans suffer from liver cirrhosis, with approximately 1.5 million of those individuals also diagnosed with portal hypertension. Beta-adrenergic receptor blocking agents, or beta blockers, such as propranolol are the most common treatment for portal hypertension. Beta blockers help to relieve the effects of portal hypertension by lowering blood pressure throughout the body. However, these products are associated with increased risk of stroke and a number of other side effects, including, nausea, diarrhea, hypotension, heart


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failure, dizziness, fatigue, insomnia and depression, which may limit their use, particularly among elderly patients. In contrast to beta blockers, we believe that SPI-8811 may be effective at reducing portal hypertension without exhibiting many of the serious side effects associated with beta blockers.
 
In preclinical tests, SPI-8811:
 
  •  decreased portal pressure in two rodent models of portal hypertension disease;
 
  •  increased cutaneous blood flow in two additional animal models in the presence of chemical agents known to constrict the peripheral vasculature; and
 
  •  reduced vascular resistance in the liver induced by a chemical agent in an isolated rat model.
 
We plan to commence a Phase II proof-of-concept study of SPI-8811 in patients with portal hypertension in 2007.
 
Non-Alcoholic Fatty Liver Disease.  Non-alcoholic fatty liver disease is characterized by elevations of specific liver enzymes in the absence of excessive alcohol intake or other chronic liver diseases. Although all levels of non-alcoholic fatty liver disease lead to fat accumulation in the liver, the more advanced versions of this disease, known as Type 3 and Type 4 non-alcoholic fatty liver disease, also involve fibrosis and greatly increase the risk of progressive liver disease, cirrhosis and liver-related death. There is currently no treatment available for non-alcoholic fatty liver disease and the market size is unknown. According to the National Institute of Diabetes and Digestive and Kidney Diseases, a division of the National Institutes of Health, approximately 10% to 20% of Americans are affected by fat in the liver, and this condition is becoming more common, possibly due to the greater number of Americans with obesity.
 
In preclinical studies of SPI-8811 as a potential treatment for non-alcoholic fatty liver disease in rodent models of liver damage, SPI-8811 was found to favorably alter various serum indicators of liver function and to reduce the severity of liver injury caused by hepatitis.
 
In June 2003, we completed a limited, 28-day Phase II trial to assess the safety and efficacy of orally administered SPI-8811 for the treatment of non-alcoholic fatty liver disease. The efficacy results of this trial were inconclusive, which we believe was likely the result of the trial’s short treatment period and the fact that all but one of the participants in this trial suffered from Type 4 non-alcoholic fatty liver disease, the most severe form of the disease. Although we believe that further investigation of the role of SPI-8811 in the prevention or delay of non-alcoholic fatty liver disease progression is warranted, current techniques for studying this condition require a biopsy of the liver. As a result, we do not plan to pursue human clinical trials of SPI-8811 for the treatment of non-alcoholic fatty liver disease until such time as less invasive methods or alternative diagnostic endpoints are developed for diagnosing the disease and evaluating its progress.
 
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 between 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, SPI-8811 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 SPI-8811 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 II trial of orally administered SPI-8811 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 SPI-8811 for seven days. SPI-8811 was generally well tolerated by trial participants, although one participant experienced a serious adverse event and was hospitalized for


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exacerbation, or short-term worsening, of the disease, possibly as a result of treatment with SPI-8811. Although this trial focused primarily on safety, we also examined the effect of SPI-8811 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. However, we did observe improvements in baseline gastrointestinal disorders associated with cystic fibrosis as measured by the questionnaire. As a result, we determined to focus our initial development efforts on the treatment of gastrointestinal disorders associated with cystic fibrosis and plan to commence a Phase II dose-ranging trial of orally administered SPI-8811 for the treatment of these disorders by the second quarter of 2008. In the future, we also plan to develop an inhaled formulation of SPI-8811 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 underdiagnosed. 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 SPI-8811 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 SPI-8811 in a guinea pig model to assess changes in respiratory and pulmonary function, SPI-8811 reduced cigarette smoke-induced airway resistance and restored forced expiratory volume. We plan to conduct additional preclinical testing of this inhaled formulation of SPI-8811 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 and 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 plan to commence Phase I clinical trials of the intravenous formulation of SPI-017 and Phase I clinical trials of the oral formulation in 2008. Results from the Phase I trials of both the intravenous and the oral formulations may be useful in the development of any of these indications.
 
In preclinical in vitro tests on human cell lines, SPI-017 activated chloride channels in very low concentrations on a variety of cells found in the central nervous system and peripheral blood vessels. We are currently evaluating the safety profile of SPI-017 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


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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 are not currently available 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.
 
In animal studies, 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.
 
While the causes of Alzheimer’s disease are currently not well understood, it is widely recognized that particular regions of the brain may play a central role in memory. 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, that bind to receptors on neighboring neurons. Coordinated communication across synapses is essential for the formation of memories.
 
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.


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Preliminary data from a preclinical study of SPI-017 in a rat model of Alzheimer’s disease suggests that orally administered SPI-017 may restore cognitive behavior. We are planning additional studies to further define the activity of SPI-017 in this animal model.
 
Marketing and Sales
 
We are co-promoting AMITIZA in the United States with Takeda. We plan to market other product candidates that we may bring to market through a combination of our own sales capabilities and co-marketing, co-promotion, licensing and distribution arrangements with third-party collaborators.
 
As we develop other products for commercialization, we intend to evaluate the merits of retaining commercialization rights for ourselves, entering into similar collaborative arrangements with leading pharmaceutical companies to help further develop and commercialize our product candidates or a combination of both. Our decision whether to enter into collaborative arrangements will be based on such factors as anticipated development costs, therapeutic expertise and the commercial infrastructure required to access a particular market. We expect that in many of these arrangements, we will seek to co-promote our products in the United States and, in some cases, other markets as part of our ongoing effort to build our internal sales and marketing capabilities.
 
As part of this strategy, we entered into a 16-year collaboration and license agreement with Takeda in October 2004 for the joint development and commercialization of AMITIZA for gastrointestinal indications in the United States and Canada. In early 2006, we exercised the co-promotion rights under our collaboration and license agreement with Takeda in order to begin developing a specialized sales force to market AMITIZA and other gastrointestinal-related products to complement Takeda’s sales efforts. Our initial strategy is to focus our marketing and sales efforts on promoting AMITIZA 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 will be a key market for AMITIZA to treat gastrointestinal indications, and by physicians who are key opinion leaders in the gastrointestinal field. Takeda is marketing AMITIZA more broadly to office-based specialty physicians and primary care physicians. Pursuant to the terms of the collaboration and license agreement, Takeda is required to provide a dedicated sales force of at least 200 people to promote AMITIZA and a supplemental sales force of at least 500 people to promote AMITIZA together with one other drug product. Takeda is currently utilizing TAP Pharmaceutical Products, Inc., or TAP, a joint venture between an affiliate of Takeda and Abbot Laboratories, to provide this supplemental sales force. Takeda has advised us that the supplemental sales force being supplied by TAP consists of over 700 people and is marketing AMITIZA together with Prevacid® (lansoprazole), a product for the treatment of gastroesophageal reflux disease, ulcers and a variety of other gastrointestinal indications.
 
In late 2005 and early 2006, in anticipation of the launch of AMITIZA, we recruited an experienced sales and marketing management team comprising an executive vice president of commercial operations, a vice president of marketing, a director of medical marketing, a national sales director and four regional sales managers.
 
In addition, effective February 2006, we entered into a contract sales agreement with Ventiv Commercial Services, LLC, or Ventiv, under which Ventiv provided us with a contract specialty sales force of 38 field sales representatives to market AMITIZA in our targeted institutional market. Our agreement with Takeda provides that Takeda will fund a significant portion of our contract sales force costs. We initially determined to engage a contract sales force through Ventiv, instead of recruiting a sales force of our own, to minimize the time necessary to launch an operational sales force following our receipt of marketing approval for AMITIZA from the FDA. In light of the size of the sales force, we also believed this approach was more cost effective in the short term than establishing our own sales force internally. In addition, under the terms of our agreement with Ventiv, we preserved the right to hire some or all of Ventiv’s contract sales representatives as our own employees after the first anniversary of their deployment in the field, subject to payment of a specified conversion fee to Ventiv.
 
We exercised our right to terminate our agreement with Ventiv and to hire a significant portion of their sales staff as employees of our company effective July 1, 2007. We believe this will improve our ability to


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recruit highly qualified sales staff and will enhance our ability to control our sales force and its deployment. Although these sales representatives have become employees of our company, we intend to continue to outsource most of the operational infrastructure associated with this sales force through a new contract with Ventiv and, in some cases, through other vendors. In connection with this internalization of our specialty sales force, we expect to incur approximately $250,000 of transition expenses, primarily recruiting and training expenses and a termination fee we paid to Ventiv, which will affect our sales and marketing expenses for the quarter ending September 30, 2007. We also anticipate that our ongoing expenses relating to this sales force will increase by approximately $400,000 annually over what those expenses would have been if we had maintained the Ventiv relationship, due to compensation increases we expect to implement.
 
We believe that the institutional focus of our specialty sales force, which targets academic medical centers and long-term care facilities, would facilitate our ability to sell other products for the treatment of a variety of indications in several therapeutic fields that are concentrated in the institutional setting, as well as additional products in our own pipeline that might be approved. In particular, we expect that our specialty sales force will develop expertise over time that could be useful in marketing additional products for the treatment of gastrointestinal indications and for the treatment of the elderly. We intend to pursue 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. The 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 related supply and purchase agreement.
 
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. This funding obligation is $10.0 million per year so long as marketing approval for the product in the United States is limited to the treatment of chronic idiopathic constipation. If we receive marketing approval in the United States for the treatment of irritable bowel syndrome with constipation and 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 increase to $80.0 million per year for three years.
 
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


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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. 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 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 after launch 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 are 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 will be 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 $50.0 million through the quarter ended March 31, 2007. Takeda is required to make an additional $30.0 million milestone payment to us as a result of our submission to the FDA in June 2007 of a supplement to our existing NDA for AMITIZA seeking marketing approval for AMITIZA for the treatment of irritable bowel syndrome with constipation. Subject to reaching future development and commercial milestones, we are entitled to receive up to $110.0 million in additional development and 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 Europe and 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.
 
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


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of another party and launches a product competitive with AMITIZA. Alternatively, either party has the right to terminate the agreement in the following circumstances:
 
  •  a breach of the agreement by the other party that is not cured within 90 days, or 30 days in the case of a breach of payment obligations;
 
  •  a change of control of the other party in which the new controlling party does not expressly affirm its continuing obligations under the agreement;
 
  •  insolvency of the other party; or
 
  •  a failure to receive marketing approval from the FDA for AMITIZA for the treatment of irritable bowel syndrome with constipation and subsequent failure of the parties to agree on an alternative development and commercialization strategy.
 
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. 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. If we have not committed specified development efforts to any prostone compound other than AMITIZA, SPI-8811 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. Kuno and Ueno 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. Sucampo AG, wholly owned by Drs. Ryuji Ueno and Sachiko Kuno and based in Zug, Switzerland, is the patent holding company that maintains the patent portfolio derived from Dr. Ueno’s research with prostone technology.
 
As of June 30, 2007, we had licensed from Sucampo AG rights to a total of 51 U.S. patents, 19 U.S. patent applications, 27 European patents, 13 European patent applications, 37 Japanese patents and 17 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, SPI-8811 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 seven issued U.S. patents, four issued European patents and two issued Japanese patents relating to composition of matter and methods of use. These patent rights also include various U.S., Europe