10-K 1 f10k_030714.htm FORM 10-K f10k_030714.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K
(Mark One)

þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2013

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________.

Commission File Number: 001-33609

SUCAMPO PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
30-0520478
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
4520 East-West Highway, 3rd Floor
 
20814
Bethesda, MD 20814
 
(Zip Code)
(Address of principal executive offices,
   
including zip code)
   
     
(301) 961-3400
(Registrant’s telephone number)

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

Title of each class
 
Name of each exchange on which registered
Class A common stock, par value $0.01
 
The NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Exchange Act:  None

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ      No o

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o                        Accelerated filer þ                          Non-accelerated filer o                     Smaller reporting company o
(Do not check if a smaller reporting company)

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

The aggregate market value of the 12,753,602 shares of class A common stock held by non-affiliates of the registrant (based on the closing price of the registrant’s class A common stock on the last business day of the registrant’s most recently completed second fiscal quarter) was $83.9 million.

As of March 3, 2014, there were outstanding 43,998,430 shares of the registrant’s class A common stock, par value $0.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s Proxy Statement for its 2014 Annual Meeting of Stockholders to be held on May 9, 2014, which Proxy Statement is to be filed within 120 days after the end of the registrant’s fiscal year ended December 31, 2013, are incorporated by reference in Part III of this Annual Report on Form 10-K.
 
 
 

 
Sucampo Pharmaceuticals, Inc.

Form 10-K
Table of Contents

   
Page
Part I
 
 
 
 
 
 
 
   
Part II
 
 
 
 
 
 
 
 
 
     
Part III
 
 
 
 
 
 
     
Part IV
 
 
 
 
 
 
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PART I

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

ITEM 1.   BUSINESS

Overview

We are a global biopharmaceutical company focused on innovative research, discovery, development and commercialization of proprietary drugs based on ion channel activators known as prostones. The therapeutic potential of prostones was first discovered by our co-founder, Dr. Ryuji Ueno. Under his leadership we have pioneered the field of prostones. Prostones are naturally occurring fatty acid metabolites which were originally thought to be biologically inert. Prostones have emerged as a promising compound class with unique physiological activities which can be targeted for the treatment of unmet or underserved medical needs.

We are focused on developing and/or commercializing prostone-based drugs to treat gastrointestinal, ophthalmic, neurologic, and oncology-based inflammatory disorders, and we are also considering other potential therapeutic applications of our drug technologies.

We currently generate revenue mainly from product royalties, development milestone payments, clinical development activities and product sales. We expect to continue to incur significant expenses for the next several years as we continue our research and development activities, seek additional regulatory approvals and additional indications for AMITIZA® (lubiprostone), RESCULA® (unoprostone isopropyl) and other compounds, commercialize our approved products (as discussed below) on a global basis and protect our intellectual property.

Our operations are conducted through subsidiaries based in Japan, the United States, Switzerland, the United Kingdom and Luxembourg. Our reportable geographic segments are Asia, the Americas and Europe and we evaluate the performance of these segments based primarily on income (loss) from operations, as well as other factors that depend on the growth of these segments. Such measures include the progress of research and development activities, collaboration and licensing efforts, commercialization activities and other factors.

Dr. Ueno and Dr. Sachiko Kuno have direct or indirect interests in our controlling stockholder, S&R Technology Holding, LLC, and are married to each other. Dr. Ueno stepped down as our Chief Executive Officer, Chairman of the Board of Directors, and Board member effective March 3, 2014 and as Chief Scientific Officer effective March 31, 2014. Beginning April 1, 2014, he will be consulting for us as the Co-Founder, Chairman Emeritus and Scientific Advisor. Dr. Kuno was a member of our Board of Directors and our executive advisor on international business development through September 30, 2012. Drs. Ueno and Kuno, together, directly or indirectly, own a majority of the stock of R-Tech Ueno, Ltd, or R-Tech, a pharmaceutical research, development and manufacturing company in Japan. R-Tech is responsible for the manufacture and supply of all of our drug products for commercial use and clinical development.

Effective March 3, 2014, Daniel P. Getman, Ph.D. became Chairman of the Board of Directors and Peter Greenleaf joined us as our Chief Executive Officer and Board member.

The Prostone Platform and Related Physiology

Prostones act locally to restore normal function in cells and tissues, and because they are quickly metabolized to an inactive form, their pharmacologic activity can be targeted to specific organs and tissues. Prostones possess a unique mechanism of action as highly potent and selective ion channel activators. Ion channels are integral parts of cell membranes that regulate the flow of specific ions into and out of cells. This regulation is critical for the functioning of metabolic processes and cell survival. As such, prostones are physiological mediators of the restoration of cellular homeostasis and tissue regeneration. There is also evidence that prostones have anti-inflammatory properties and can prevent cell death.

 
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Our prostone-based compounds target the ClC-2 (chloride) and big potassium, or BK, ion channels. Because these ion channels play an important role in physiology, targeted dosing of prostones may have broad applicability in many disease states in different organ systems. We have developed synthetic analogs of the naturally occurring prostones, which have been optimized to be more potent, selective, and stable, thus enabling their use as drugs. These synthetic prostones are very selective for their molecular targets, and the approved prostone-based compounds are well-tolerated and generally safe.

We are the only company developing and commercializing prostone compounds on a global basis. We have established a broad patent estate of over 525 active issued patents based on our proprietary prostone technology.

Product Pipeline

The table below summarizes the development status of lubiprostone, unoprostone isopropyl and several other prostone-based 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 under our collaboration and license agreement with Takeda Pharmaceutical Company Limited, or Takeda, and in Japan under our collaboration and license agreement with Abbott Japan Co. Ltd., or Abbott. We hold all commercialization rights for unoprostone isopropyl globally except for Japan, Korea, Taiwan and the People’s Republic of China, or R-Tech Territory.

Product/Product Candidate
 
Target Indication
 
Development Phase
 
Next Milestone
Lubiprostone (AMITIZA ®)
 
Chronic idiopathic constipation (CIC) (adults of all ages)
 
Marketed in the U.S.
 
_____
             
       
Marketed in Switzerland
 
_____
             
       
Marketed in the U.K. Initiated mutual recognition process (MRP) for approval in other E.U. countries.
 
Will consider seeking approval for AMITIZA in other E.U. countries following the MRP
             
   
Irritable bowel syndrome with constipation (adult women) (IBS-C)
 
Marketed in the U.S.
 
Initiate phase 4 study on higher dosage and with additional male subjects
             
   
Opioid-induced constipation (OIC) in patients with chronic non-cancer pain
 
sNDA approved in U.S. in Q2 2013.  MAA submitted in Switzerland and U.K. in Q1 2013
 
Discuss with MHRA regulatory options for obtaining OIC approval in the U.K
             
   
Chronic constipation
 
Marketed in Japan since Q4 2012
 
_____
             
   
Liquid formulation
 
Phase 3 trial initiated
 
Complete phase 3 trial; analyze results and file NDA
             
   
Pediatric functional constipation
 
Pivotal phase 3 initiated
 
Complete phase 3 program and file sNDA
             
Unoprostone Isopropyl (RESCULA ®)
 
Primary open angle glaucoma and ocular hypertension
 
Launched in the U.S. in Q1 2013
 
_____
             
   
Glaucoma and ocular hypertension
 
_____
 
Updated label and reauthorization in the E.U. and Switzerland
             
   
Retinitis pigmentosa
 
In phase 3 by development partner R-Tech Ueno.  Orphan drug status obtained in the U.S. and E.U.
 
Meet with the U.S. and European regulators prior to the interim results of Japanese trial
             
IV Ion Channel Activator
 
Lumbar spinal stenosis
 
Phase 2a completed
 
Initiate additional phase 2a trial
             
PO Ion Channel Activator
 
Lumbar spinal stenosis
 
Phase 1a completed
 
Initiate phase 1b trial
             
Cobiprostone
 
Oral mucositis
 
Phase 1b initiated
 
Complete phase 1b trial
 
Our Prostone Products, Approved and in Clinical Development

 
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AMITIZA (lubiprostone)

AMITIZA is well-tolerated and has a well-established efficacy profile. Since 2006, AMITIZA has been dispensed over 8 million times. Post marketing safety monitoring indicates that the safety profile is similar to the well-tolerated safety profile for AMITIZA seen in clinical trials. Side effects reported in clinical testing were predominantly mild to moderate and transient in nature. The most commonly reported adverse events in the clinical trials for chronic idiopathic constipation, or CIC, were nausea, diarrhea, headache, abdominal pain, abdominal distension, and flatulence; for irritable bowel syndrome with constipation, or IBS-C, were nausea, diarrhea, and abdominal pain; and for opioid-induced constipation, or OIC, were nausea and diarrhea. AMITIZA users tend to be satisfied with their treatment. In market research, the majority of AMITIZA users reported a high level of satisfaction with AMITIZA (scoring 6 or 7 on a 7-point scale).

Previously, three medicines used to treat CIC and IBS and one opioid antagonist for OIC were either removed from the market or had severely reduced labeling due to safety concerns. An important consideration in any medicine for chronic constipation is having an established safety profile. We believe new medicines indicated for chronic treatment of CIC, IBS or OIC will have to demonstrate a post-marketing safety profile prior to extensive first line use.

United States

AMITIZA was the first chloride channel activator approved by the FDA for the chronic treatment of CIC in adults of both genders and for IBS-C in women aged 18 years and older with demonstrated safety and efficacy for use beyond 12 weeks.

In April 2013, we received approval for a supplemental new drug application, or sNDA, for AMITIZA at dosage strength of 24 micrograms twice daily as the first and only oral medication for the treatment of OIC, in adult patients with chronic, non-cancer pain.

We and Takeda jointly develop and Takeda commercializes AMITIZA for CIC, IBS-C and OIC in the United States and Canada under the Takeda Agreement. More information on our collaboration with Takeda is found under the heading “Takeda Collaboration.”

Chronic Idiopathic Constipation (CIC)

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, or CC, is idiopathic if it is not caused by other diseases or by use of medications. Symptoms of CIC include straining, hard stools, bloating and abdominal pain or discomfort. Some patients suffering from occasional constipation may be treated with lifestyle modification, dietary changes and increased fluid and fiber intake, although there is very limited well-controlled clinical trial data in support of these alternatives in CIC or IBS-C patients. For patients who fail to respond to these approaches, physicians may recommend laxatives, most of which are available over-the-counter (not prescription), or OTC, for acute use. These agents do not have approved indications for long-term use by CIC or IBS-C patients nor is such use supported by long-term, well-controlled pivotal clinical trial data.
 
A meta-analysis published in The American Journal of Gastroenterology in September 2011 estimates that approximately 14% of adults over 15 years of age, or over 30 million people, in the United States, suffer from CIC. By the time most CIC patients seek care from a physician they have typically tried dietary and lifestyle changes as well as a number of available OTC remedies and remain unsatisfied. OTC medications include laxatives, stool softeners or fiber supplementation.

Irritable Bowel Syndrome with Constipation (IBS-C)

IBS is a disorder of the intestines with symptoms that include severe cramping, pain, bloating and changes of bowel habits, such as diarrhea or constipation. Patients diagnosed with IBS are commonly classified as having one of four forms: IBS-C, IBS with diarrhea, mixed-pattern IBS alternating between constipation and diarrhea, and unspecified irritable bowel syndrome. Currently, IBS in all its forms is considered to be one of the most common gastrointestinal disorders. Like CIC, some patients suffering from IBS-C may be treated with dietary measures, such as increasing fiber and fluid intake, or, if these measures prove ineffective, laxatives are frequently used for the management of this condition, though they are not approved for IBS-C.
 
Opioid-Induced Constipation (OIC)

 
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OIC is a common adverse effect of chronic opioid use affecting patients taking opioids. Binding of opioids to peripheral opioid receptors in the gastrointestinal tract results in absorption of electrolytes, such as chloride, and subsequent reduction in small intestinal fluid. In addition, activation of enteric opioid receptors results in abnormal gastrointestinal motility. Together, these processes result in OIC, which is characterized by infrequent and incomplete evacuation of stool, hard stool consistency, and straining associated with bowel movements.
 
Current treatment options for OIC include the use of stool softeners, enemas, suppositories and peristaltic stimulants such as senna, which stimulate muscle contractions in the bowel.  Additionally, the standard prescription option for OIC is osmotic laxatives.  The effectiveness of these products for the treatment of OIC 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. Opioid drugs are known to suppress firing of secretomotor neurons in the gut which reduces intestinal fluid secretion resulting in drier, harder stools.  Lubiprostone bypasses the opioid effect to work locally in the gut to reestablish fluid secretion thus alleviating OIC. As a result, we believe that AMITIZA holds a competitive advantage over drugs that do not work through this mechanism of action, and to date is the only oral approved product for the treatment of non-cancer OIC.
There are more than 200 million prescriptions for opioid use in the United States annually, and a substantial number of these prescriptions are for non-cancer chronic pain. Market research indicates that there are approximately 2.5-4.5 million moderate to severe sufferers of OIC, and 40-80% of patients taking opioids chronically for non-cancer pain report constipation in the United States.

Japan
 
In Japan, AMITIZA was approved for the treatment of chronic constipation, or CC, excluding constipation caused by organic diseases, by the Ministry of Health, Labour and Welfare, or MHLW, in June 2012. On December 1, 2013, the two-week limitation on prescriptions, generally applied to all new approvals of products for the first year after NIH reimbursement price approval, was removed. AMITIZA is Japan’s only prescription medicine for CC.

Chronic Constipation (CC)

According to MHLW epidemiology data, millions of people in Japan may live daily with the pain and discomfort of chronic constipation, yet not seek physician care. Medical attention could mean early diagnosis and effective, long-term treatment.

It is estimated that approximately 14.3% of the Japanese population, or over 18 million people, suffer from chronic constipation.
 
In Japan, AMITIZA is currently marketed under the Abbott Agreement. More information on our collaboration with Abbott is found under the heading “Abbott Collaboration”.

Europe
 
In the United Kingdom, we received approval in September 2012 from the Medicines and Healthcare Products Regulatory Agency, or MHRA, for the use of AMITIZA to treat CIC, but in March 2014 we received notification from MHRA that the application for the OIC indication was not approved. We made AMITIZA available in the United Kingdom in the fourth quarter of 2013 and we are currently working to achieve National Institute for Health and Care Excellence endorsement for CIC.
 
In Switzerland, AMITIZA was approved to treat CIC in 2009. In 2012, we reached an agreement with the Bundesamt fur Gesundheit, or BAG, on a reimbursement price and limitations for AMITIZA in Switzerland, and began active marketing in the first quarter of 2013. In February 2014, we announced that the BAG revised several reimbursement limitations with which AMITIZA was first approved for reimbursement and inclusion in the Specialitätenliste, or SL, to allow all Swiss physicians to prescribe AMITIZA to patients who have failed previous treatments with at least two laxatives over a nine month period. The SL limitations that were revised are:
 
·
All Swiss physicians, not just gastroenterologists, may prescribe AMITIZA;
 
·
The change in the maximum treatment duration of AMITIZA increased from 12 to 52 weeks before a review is needed by a health insurance health care practitioner; and
 
·
The BAG removed from AMITIZA’s SL a group limitation pertaining to the number of AMITIZA packs that physicians can prescribe at one time.
 
We filed for the OIC indication in Switzerland in the first quarter of 2013, and in the United Kingdom in the second quarter of 2013. We were notified on March 7, 2014 that the MHRA did not approve the application for the OIC indication in the United Kingdom. We are considering the appropriate next steps with MHRA. We anticipate a decision in Switzerland in the first half of 2014. We are considering seeking approval for AMITIZA in other European Union countries following the Mutual Recognition Procedure, or MRP.
 
 
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Chronic Idiopathic Constipation (CIC)
 
A meta-analysis published in The American Journal of Gastroenterology in September 2011 estimates that approximately 16% of adults over 15 years of age, or over 42 million people, in Northern Europe suffer from CIC.
 
A study published in Alimentary Pharmacology and Therapeutics in 2012 was conducted in ten European countries, including Switzerland, which demonstrated that approximately 28% of the participants suffering from constipation for at least 6 months were dissatisfied with their current treatment options using laxatives. As a result, approximately 83% of these patients are interested in seeking alternative methods to relieve their constipation. Additionally, patients in this study reported they want relief from all of their symptoms and to feel normal.
 
Other Global Markets
 
We and Takeda are currently exploring the commercialization of AMITIZA in Canada and we have met with Health Canada to discuss the best ways to proceed with AMITIZA registration in this market in the near future.
 
We continue to explore options to develop and commercialize lubiprostone in other geographic regions, inclusive of Latin America, Russia, the Middle East, the People’s Republic of China and other Asian countries.
 
RESCULA (unoprostone isopropyl)
 
In the United States, a sNDA for RESCULA (unoprostone isopropyl ophthalmic solution) 0.15% for the lowering of intraocular pressure, or IOP, in patients with open-angle glaucoma or ocular hypertension was approved by the FDA in December 2012. According to the approved product labeling, RESCULA may be used as a first-line agent or concomitantly with other topical ophthalmic drug products to lower IOP. RESCULA is a BK channel activator, which is different from other IOP lowering agents.
 
RESCULA provides an alternate route for IOP reduction. It is believed to reduce elevated IOP by increasing the outflow of aqueous humor through the trabecular meshwork. The product may also have a local effect on BK channels and ClC-2 chloride channels. Unoprostone isopropyl is a member of our family of prostones and is a synthetic docosanoid.
 
RESCULA has been shown to be an effective medicine in lowering IOP in patients with open-angle glaucoma and ocular hypertension and has demonstrated an excellent systemic safety profile and an established ocular side effect profile. RESCULA provides efficacy throughout the day and over the long-term. In pivotal trials at 6 months, RESCULA reduced mean IOP by ~3 to 4 mm Hg throughout the day (for 12 hours) with a flat diurnal curve (mean baseline IOP: 23 mm Hg). RESCULA had no deleterious effect on cardiovascular or pulmonary function in clinical studies, and minimal systemic absorption and exposure.
 
RESCULA was originally approved by the FDA in 2000 for the lowering of IOP in open-angle glaucoma and ocular hypertension in patients who are intolerant of or insufficiently responsive to other IOP lowering medications. RESCULA first launched in Japan in 1994, and since then over 53 million bottles have been shipped. In April 2009, we acquired the commercialization rights to RESCULA for the United States and Canada from R-Tech.
 
We began commercializing RESCULA in the United States in February 2013.  In November 2013 we decided to eliminate our in-house sales force and deploy a contract sales force. Beginning in January 2014, we significantly decreased the amount of in-person sales calls for RESCULA by using a contract sales force to detail only current RESCULA prescribers. We also use a limited mix of inside sales and other promotional tactics, including digital, to reach the current non-prescriber base in an effort to increase prescribers and sales of RESCULA.
 
Our Other Clinical Development Programs
 
Lubiprostone
 
Liquid Formulation
 
In October 2013, we announced the initiation of a pivotal trial of a liquid formulation of lubiprostone 24mcg twice daily in adults with CIC. Upon reviewing the results of this trial, which we anticipate to end in the first half of 2014, we plan to file a new drug application for approval.
 
 
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Pediatric Functional Constipation
 
Constipation in children has similar characteristics to that of constipation in adults in that symptoms include infrequent bowel movements, hard stools, large diameter stools and painful passage of stools. Rome III diagnostic criteria for childhood functional constipation dictate that such symptoms occur at least once per week for at least 2 months prior to diagnosis. Children may also experience fecal retention due to withholding. There is a tendency to avoid defecation and withhold bowel movements as a result of pain experienced from the passage of large stools. This withholding of bowel movements can result in episodes of fecal incontinence. Ninety percent of pediatric constipation is functional constipation and it occurs in all age groups.
 
An analysis of longitudinal data in the United States showed a nearly 4-fold increase in rates of constipation over the last decade. Estimates of the prevalence rate of functional constipation in the pediatric population worldwide have varied greatly, from 4 to 37%. Only 50-70% of children with functional constipation demonstrate long-term improvement with the current treatments.
 
In December 2013, we announced the initiation of the pivotal phase 3 clinical program of AMITIZA in pediatric functional constipation. This is the first of a series of global, multicenter phase 3 studies to evaluate the efficacy, safety, and pharmacokinetics of AMITIZA capsules in patients ≥ 6 months through 17 years of age with pediatric functional constipation. We also plan to evaluate the long-term safety of AMITIZA in these populations through two open-label extension studies. One of the pediatric trials will also use the liquid formulation.
 
Unoprostone Isopropyl
 
We continue to pursue additional intellectual property as well as further clinical development of unoprostone isopropyl. In clinical and preclinical studies, unoprostone isopropyl has increased ocular blood flow to the optic nerve and in the choroid; maintained visual field; delayed retinal degeneration induced by rhodopsin; inhibited topographic and blood changes in an ischemic optic nerve head; and lowered intraocular pressure. We believe that unoprostone isopropyl could potentially be effective in the treatment of other ocular diseases.
 
Retinitis Pigmentosa
 
Retinitis pigmentosa, or RP, is a genetic disease characterized by progressive, irreversible vision loss and decreasing visual acuity. RP represents the most common hereditary cause of blindness in people from 20 to 60 years old. As RP progresses, daily life becomes increasingly difficult. Blindness from all causes is among the most significant injuries to a patient’s quality of life and is a major driver of patient-based cost of care and lifestyle maintenance.
 
We have received orphan drug designation for unoprostone isopropyl from the FDA for the treatment of RP and from EMA. In February 2013, we announced that the Japan Science and Technology Agency, or JST, adopted unoprostone isopropyl ophthalmic solution .15% in the Adaptable and Seamless Technology Transfer Program. As part of this program, R-Tech, our development partner, has signed an agreement for unoprostone isopropyl with the JST in which the Japanese government shall provide the majority of funding for phase 3 clinical development costs for unoprostone isopropyl for RP. In October 2013, we announced that R-Tech completed patient enrollment of the phase 3 clinical development for unoprostone isopropyl for RP. We have the rights to the clinical data for potential filing in Europe and the United States and will decide on our path forward assuming the Japanese trial is successful. Additionally, we are currently evaluating opportunities in other retinal diseases, such as age-related macular degeneration.
 
An article published in Current Genomics in 2011 estimates that approximately one in every 3,000 to 5,000 individuals, or over 170,000 people worldwide, suffers from RP.
 
Intravenous (IV) and Oral (PO) Ion Channel Activators
 
Lumbar Spinal Stenosis
 
We have both an IV ion channel activator and a PO ion channel activator in development for the treatment of lumbar spinal stenosis, or LSS. These compounds may also be investigated for other indications in the future. LSS is caused by degenerative change in the lumbar spine, and it is a very common disease observed in the growing aging population. It is the narrowing of the spinal canal that usually starts gradually and develops over a long period of time. As the spinal canal narrows, it can squeeze (compress) and irritate the nerve roots that branch out from the spinal cord, resulting in lower back pain, as well as pain, weakness, and numbness in the legs.
 
In the United States and Europe, there are no medications specifically approved for the pain associated with the treatment of lumbar spinal stenosis. Commonly used medications to address the symptoms are NSAIDS, muscle relaxants, tricyclic antidepressants, short-term oral opioids, and membrane-stabilizing convulsants (such as carbamazepine), although all have potential side effects that may complicate their use. In Japan, limaprost alfadex, a prostaglandin analogue, is the only approved medication for the improvement of subjective symptoms (pain and numbness of lower legs) and gait ability associated with acquired lumbar spinal canal stenosis (in patients with bilateral intermittent claudication showing normal SLR test result). Prostaglandins do not always achieve desired results, and while rare, severe side effects have been experienced with its use.
 
 
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It is estimated that about 400,000 Americans, most over the age of 60, may be suffering from the symptoms of lumbar spinal stenosis. There are as many as 1.2 million Americans with back and leg pain related to any type of spinal stenosis.
 
In December 2013, we reported results of the treatment phase of our phase 2a, double-blind, placebo-controlled study of the IV version of our ion channel activator for LSS, that indicated statistically significant improvement in Visual Analog Scale pain. We plan to initiate an additional phase 2a in the second half of 2014 with a revised protocol and different patient group.
 
The PO ion channel activator for phase 1a clinical development results were reported in August 2013, and demonstrated that the compound is generally well-tolerated. We plan to initiate the next phase of clinical development in the first quarter of 2014.
 
Cobiprostone
 
Oral Spray for Oral Mucositis
 
Cobiprostone, like AMITIZA, is an activator of the chloride ion channel, ClC-2, which is known to be present in gastrointestinal, liver and lung cells. Our most advanced area of development for cobiprostone is the prevention and/or treatment of oral mucositis, or OM. We are also investigating the potential for cobiprostone for oral administration in other disease areas.
 
OM refers to the inflammation of oral mucosa resulting from chemotherapy, or CT, and or radiation therapy, or RT. OM, or tissue swelling, symptoms include mouth pain, sores, infection, and bleeding. The condition is typically manifested as erythema or ulcerations, and may be exacerbated by local factors. Erythematous mucositis typically appears 7-10 days after initiation of high-dose cancer therapy. OM is the primary dose limiting side effect that accounts for greater than 60% of the treatment interruptions. Other resulting outcomes of OM include weight loss, use of feeding tube, hospitalization and dysphagia. RT patients for head and neck cancer are at high risk of developing OM in the 89-100% range depending on if the radiation therapy is in combination with chemotherapy or altered fractionation RT. Additionally, patients being treated for hematopoietic stem cell transplant and other types of cancer are also at risk for developing oral mucositis.
 
OM current treatment includes basic oral care, cryotherapy, topical rinses such as lidocaine and carbomer and palifermin, a growth factor. There is currently no treatment available to address multiple aspects of this disease, consequently creating an unmet medical need.
 
There are approximately 5 million head and neck cancer patients globally, including approximately 350,000 in the United States. It is estimated that 80-90% of the United States population that receives radiotherapy and chemotherapy for head and neck cancer will experience some grade of oral mucositis during their treatment.
 
In August 2013, we reported results of our phase 1a trial for the oral spray formulation of cobiprostone that demonstrated the compound is to be generally well-tolerated in healthy volunteers. In October 2013, we initiated a phase 1b clinical development study, which is expected to conclude in the first half of 2014.
 
Takeda Collaboration
 
Under the Takeda Agreement, we and Takeda jointly develop and Takeda commercializes AMITIZA for gastrointestinal indications in the United States and Canada. We have limited co-promotion rights under the Takeda Agreement. Takeda does not have the right to manufacture AMITIZA. We also entered into ancillary agreements: a supply and manufacturing agreement with Takeda and R-Tech, under which R-Tech manufactures and Takeda purchases all supplies of the product from R-Tech, and an intellectual property agreement with Takeda. We also entered into a settlement agreement and Supplemental Takeda Agreement.
 
Development Costs. Takeda has agreed to fund all development costs, including regulatory-required studies, to a maximum of $50.0 million for each additional indication and $20.0 million for each additional formulation. Takeda and we have agreed to equally share all costs in excess of those amounts. With respect to any studies required to modify or expand the label for AMITIZA for the treatment of CIC, IBS-C or OIC, Takeda has agreed to fund 70% of the costs of such studies, and we have agreed to fund the remainder. Additionally, Takeda has agreed to fund 100% of the development costs for the liquid formulation of AMITIZA, and 70% of the development costs for the treatment of pediatric functional constipation. From inception of the Takeda Agreement to December 31, 2013, Takeda has reimbursed us an aggregate of $114.7 million in research and development expenses.

Commercialization Funding Commitment. Takeda is required to provide the funding levels necessary to fulfill its best effort obligations under the Takeda Agreement.
 
Promotion and Marketing. Takeda is required to provide the sales force necessary to fulfill its best effort obligations. In addition, Takeda is required to perform specified minimum number of professional product detail meetings with certain health care professionals throughout the term of the Takeda Agreement.
 
 
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Co-Promotion Rights. Under the Takeda Agreement, we retain the right to co-promote AMITIZA for gastrointestinal indications. We retained the exclusive right to develop and commercialize lubiprostone in the United States and Canada for all indications other than gastrointestinal indications. The reimbursement of co-promotion costs under the Supplemental Takeda Agreement expired on May 31, 2011. Co-promotion costs after May 31, 2011 are reimbursed under the Takeda Agreement. The previous reimbursement terms of the Supplemental Takeda Agreement were based on a per diem reimbursement by number of sales representatives in the field promoting AMITIZA, and reimbursement terms under the Takeda Agreement are based on actual sales representatives details presented to health care prescribers. In November, 2013, we announced that we would be exercising our co-promotion option and will begin co-promoting AMITIZA for OIC in adults with chronic, non-cancer pain in the first quarter of 2014.
 
Licensing Fees, Milestone Payments and Royalties. Takeda made an upfront payment of $20.0 million in 2004, and has paid additional total development milestone payments of $140.0 million through December 31, 2013, which includes a $10.0 million milestone payment as a result of the commercial launch of the OIC indication in the second quarter of 2013. Takeda records all sales of AMITIZA in the United States and Canada and pays us a tiered royalty based on net sales of AMITIZA sold in the United States and Canada. There can be no assurances that we will receive additional development or commercial milestone payments under our Takeda Agreement.
 
Administration. Our collaboration with Takeda is administered in part by four committees consisting of an equal number of representatives from both companies. These consist of a joint steering committee, which considers 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 the chief operating officer of Takeda has the determining vote on matters arising from the joint commercialization committee. If disputes relating to an alleged breach of the agreement arise that are not resolved by the chief executive officer of our company and chief operating officer of Takeda, those disputes are resolved under the breach, termination and arbitration provisions of the Takeda Agreement.
 
New Indications. 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 outside of gastrointestinal indications that we may develop. We retain the rights to AMITIZA for all other therapeutic areas. We and Takeda are currently exploring the commercialization of AMITIZA in Canada and have met with Health Canada to discuss the best ways to proceed with AMITIZA registration in this market in the near future.
 
If one of our subsidiaries or licensees wishes to use certain proprietary data or information developed under the collaboration with Takeda outside the United States or Canada, for example in support of a regulatory filing in Europe or Asia, we are obligated to pay to Takeda upon the first commercial sale a certain one-time fee for the use of such data or information. The amount of the fee for certain subsidiaries or sub-licensees is set forth in the Takeda Agreement.
 
Term. The Takeda Agreement continues until 2020 unless terminated earlier. We may terminate the agreement if Takeda fails to achieve specific levels of net sales revenue or if Takeda comes under the control of another party and launches a product competitive with AMITIZA. Alternatively, either party has the right to terminate the agreement in the following circumstances:

·
a material breach of the agreement by the other party that is not cured within 90 days of notice thereof, 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; or
·
insolvency of the other party.

Abbott Collaboration

In February 2009, we entered into a license, commercialization and supply agreement with Abbott to develop and commercialize lubiprostone for the treatment of CIC in Japan. The Abbott Agreement also grants Abbott the right of first exclusive negotiation to any additional indications for which lubiprostone is developed in Japan under all relevant patents, know-how and trademarks. We have retained all other rights to AMITIZA in Japan.

Development Costs. We are required to fund and complete all the development work including additional clinical studies required to obtain regulatory approval for the treatment of CIC in Japan. We own all the rights covered under the regulatory filings.

Commercialization Funding Commitment. Abbott is required to fund and undertake all commercialization efforts including pre-launch and post-launch marketing, promotion and distribution. Abbott is required to maintain the number of sales staff and the estimated level of annual net sales based on the commercialization plan to be developed and approved by the joint commercialization and steering committee described below.

 
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Co-Promotion Rights. We have retained the right to co-promote the product in Japan under certain conditions and all other development and commercialization rights to all other therapeutic areas and are responsible for the cost of co-promotion.

Licensing Fees and Milestone Payments. Abbott made an upfront payment of $10.0 million in 2009 and has paid total development milestone payments of $27.5 million through December 31, 2013, which includes a $15.0 million milestone payment as a result of the November 2012 first commercial sale in Japan. There can be no assurances that we will receive additional development or commercial milestone payments under our agreement with Abbott.

Product Revenue. With the commencement of product sales of AMITIZA in Japan in the fourth quarter of 2012, we now purchase and assume title to inventories of AMITIZA, and recognize revenues from the sales to Abbott of such product when earned.

Administration. Our collaboration efforts under the Abbott Agreement are administered by two committees consisting of an equal number of representatives from both parties. The joint commercialization and steering committee oversees commercialization-related activities and resolves any conflicts arising from a joint development committee, which oversees the development-related activities in Japan. The dispute mechanism under the Abbott Agreement provides Abbott with final decision regarding disputes over commercialization of the products, while we have the same rights with respect to disputes over the development of the product.

New Indications. Abbott has a right of first exclusive negotiation to obtain a license to develop and commercialize AMITIZA in Japan for any new indications that we may develop, such as OIC. We retain the rights to AMITIZA for all other therapeutic uses.

Term. The Abbott Agreement continues until 2027 unless terminated earlier. Either party has the right to terminate the agreement in the following circumstances:

·
a material breach of the agreement by the other party that is not cured within 90 days of notice, or
·
insolvency of either party.

Intellectual Property

Our success depends in part on our ability, and that of R-Tech, 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 the ownership rights to develop and commercialize lubiprostone and many other prostone compounds covered by patents and patent applications. In addition we hold licenses to develop and commercialize unoprostone isopropyl in certain territories. Our portfolio of patents includes patents or patent applications with claims directed to compositions of matter, including both compounds and pharmaceutical formulations, or methods of use, or a combination of these claims, or methods of manufacturing lubiprostone, cobiprostone, and ion channel activators. As of December 31, 2013, these include a total of 47 U.S. patents, 39 U.S. patent applications, 20 European patents, 33 European patent applications, 32 Japanese patents and 27 Japanese patent applications. We license the rights to certain unoprostone patents from R-Tech. 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 a 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 lubiprostone consist of 25 issued U.S. patents, 10 issued European patents, and 16 issued Japanese patents relating to compositions of matter, methods of use and methods of manufacturing. These patent rights also include various U.S., European and Japanese patent applications relating to dosing regimens, pharmaceutical formulations and other claims. The U.S. patents relating to compositions of matter expire between 2014 and 2027. The other U.S. and foreign patents expire between 2020 and 2029.

The patent rights relating to cobiprostone consist of 23 issued U.S. patents, 10 issued European patents, and 17 issued Japanese patents relating to compositions of matter, methods of use and methods of manufacturing. These patent rights also include various U.S., European and Japanese patent applications relating to dosing regimens, pharmaceutical formulations and other claims. The U.S. patents relating to compositions of matter expire between 2014 and 2027. The other U.S. and foreign patents expire between 2015 and 2029.

The patent rights relating to ion channel activators consist of 8 issued U.S. patents, 5 issued European patents, and 7 issued Japanese patents relating to compositions of matter, methods of use, pharmaceutical formulations and other claims. The U.S. patents relating to compositions of matter expire in 2021. The other U.S. patents and foreign patents expire between 2018 and 2032.

The patent rights relating to unoprostone isopropyl licensed from R-Tech consist of 6 issued U.S. patents relating to compositions of matter, methods of use, pharmaceutical formulations and other claims. The U.S. patents relating to compositions of matter expire in 2018 and method of use in 2032. The other U.S. and foreign patents expire between 2016 and 2032.

 
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We are actively seeking to augment our portfolio of compounds by focusing on the development of new chemical entities, or NCEs, such as cobiprostone, and ion channel activators, which have not previously received FDA approval. Upon approval by the FDA, NCEs are entitled to market exclusivity in the United States with respect to generic drug products for a period of five years from the date of FDA approval, even if the related patents have expired. We are also engaged in lifecycle management strategies for our marketed products.

As a result of a notification of a patent challenge and generic drug application submission for AMITIZA, on February 8, 2013, we announced that we, along with R-Tech and Takeda, filed a patent infringement lawsuit in the United States District Court for the District of Delaware against Anchen Pharmaceuticals, Inc., or Anchen, and Par Pharmaceuticals, Inc. and Par Pharmaceutical Companies, Inc., or Par. The lawsuit claims infringement of seven patents that are listed in the FDA’s Orange Book and that are scheduled to expire between 2020 and 2027.

Manufacturing

We do not own manufacturing facilities for the production of commercial quantities of AMITIZA or preclinical or clinical supplies of the other prostone compounds that we are testing in our development programs. Instead, we contract with R-Tech as the sole manufacturer of our products to produce AMITIZA, RESCULA, cobiprostone and ion channel activators and any of our future prostone compounds. We have entered into multiple exclusive supply arrangements with R-Tech and we have granted to R-Tech the exclusive right to manufacture and supply AMITIZA and other products and compounds to us to meet our commercial and clinical requirements. With the exception of the exclusive supply agreements with Takeda, R-Tech is prohibited from supplying AMITIZA to anyone other than us during this period. Our supply arrangement with R-Tech also provides that R-Tech will assist us in connection with applications for marketing approval for AMITIZA, including assistance with regulatory compliance for chemistry, manufacturing and controls. In consideration of these exclusive rights, R-Tech has paid to us $8.3 million in upfront and milestone payments as of December 31, 2013. Either we or R-Tech may terminate the supply arrangement with respect to us in the event of the other party’s uncured breach or insolvency. R-Tech is obligated to make additional payment upon regulatory or commercial milestones.

Under the supply agreement we have with Takeda and R-Tech, which covers the period of our Takeda Agreement, R-Tech agreed to supply all Takeda’s commercial supplies, including product samples, for AMITIZA for the United States and Canadian market. Pursuant to the terms of these agreements, Takeda is required to provide R-Tech with a rolling 24-month forecast of its product and sample requirements and R-Tech is required to keep adequate levels of inventory in line with this forecast. Upon termination of the collaboration and license agreement between Takeda and us, Takeda and we may terminate these supply agreements by notice to R-Tech and Takeda is not required to purchase the quantity of the product and/or samples contained in its binding forecast.

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

We also have a supply agreement with R-Tech for the supply of AMITIZA to Abbott under the Abbott Agreement and for supply for Europe, Middle East and Africa. These long-term agreements supply all Abbott’s and our commercial supplies, including product samples, for AMITIZA for the Japan, Switzerland and UK markets. Like the Takeda arrangement, a 24-month rolling forecast of product and sample requirements is required for Japan and a 12-month rolling forecast is required for the Switzerland and UK markets and R-Tech is required to keep adequate levels of inventory in line with these forecasts. In the event that R-Tech cannot meet some or all of Abbott’s or our demand, we do not have alternative manufacturing arrangements in place but R-Tech is required to keep commercially reasonable supplies on hand. R-Tech shall maintain a safety stock of active drug substance equal to six (6) months of forecast demand based on Abbott's most recent rolling forecast. R-Tech shall maintain a safety stock of additional materials to support the drug product manufacture and packaging equal to three (3) months of forecast demand based on Abbott's most recent rolling forecast. R-Tech and we are currently negotiating an exclusive manufacturing and supply agreement to take the place of the supply agreements for all territories other than Japan, US and Canada.

In 2009, we entered into an exclusive supply agreement with R-Tech for ten years to supply us with unoprostone isopropyl for the United States and Canada. In addition we have also entered into an exclusive supply arrangement with R-Tech to provide us with clinical supplies of our product candidates, cobiprostone and ion channel activators, as well as any other prostone compounds we may designate, and to assist us in connection with applications for clinical trials and marketing approval for these, including assistance with regulatory compliance for chemistry, manufacturing and controls. This clinical supply arrangement has a two year term which renews automatically for one-year periods unless we and R-Tech agree not to renew it. Either we or R-Tech may terminate the clinical supply arrangement with respect to us or one of our operating subsidiaries in the event of the other party’s uncured breach or insolvency. In March 2012, R-Tech informed us that it was relocating its manufacturing facility to Sanda, Japan for unoprostone isopropyl beginning October 2012. R-Tech has decided to contract with NittoMedic in Japan for the manufacture of unoprostone isopropyl but NittoMedic’s facility needed to be inspected by the FDA before it can manufacture unoprostone isopropyl. In light of this change in facility, we placed an order to sufficiently cover this supply period based on our forecasts for the launch of RESCULA in the United States and regulatory requirements in the E.U. R-Tech delivered that order to us in the first and second quarters of 2013.  We filed a supplemental new drug application, or sNDA, in July 2013 for the new facility. The NittoMedic facility was inspected by the FDA in the fourth quarter of 2013. As a result of the inspection, FDA issued deficiencies to NittoMedic and a complete response letter to us with regard to the drug master file. NittoMedic has responded to the deficiencies and we have asked FDA to proceed with its review of the sNDA, which it has indicated it will do so. We are awaiting the decision by the FDA.

 
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Competition

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

AMITIZA

Many patients are treated for CIC or IBS-C with competing OTC or prescription products, most of which are sold for occasional or infrequent constipation. In December 2012, linaclotide, a guanylin agonist dosed once a day 30 minutes before a meal, was approved for CIC and IBS-C. In the United States, Ironwood and Forest Pharmaceuticals, Inc. are co- marketing linaclotide. In November 2012, linaclotide (co-marketed by Ironwood and Almirall, S.A.) was approved in Europe for IBS-C in adults. In Japan, Ironwood and Astellas Pharma US, Inc. initiated a double-blind, placebo-controlled, dose-ranging phase 2 clinical trial of linaclotide in Japanese adult patients with IBS-C but it was reportedly unsuccessful, and in China, Ironwood and AstraZeneca have a co-development and co-commercialization agreement for linaclotide.
 
Several companies also are working to develop new drugs and other therapies for CIC, IBS-C, and/or OIC. Some of these potential competitive drug products include:

·
Plecanatide, a guanylate cyclase-C agonist, is being developed by Synergy Pharmaceuticals, Inc., or Synergy, which has completed a phase 2b/3 trial in CIC and is conducting a phase 2b study in IBS-C.
·
Prucalopride is being developed and marketed by Shire for the treatment of CC in adults in the E.U. Prucalopride received marketing approval in the E.U., Switzerland, Iceland, Liechtenstein and Norway for the symptomatic treatment of CC in women in whom laxatives fail to provide adequate relief.  Prucalopride was launched in several European markets. Shire intends to develop prucalopride in the United States for CC.
·
SK Biopharmaceuticals commenced a phase 2 trial in 2012 to study YKP 10811, a 5-HT4 partial agonist, for CIC.
·
In July 2012, Ferring Pharmaceuticals acquired the global licensing rights (excluding Japan) for elobixibat, an IBAT (ileal bile acid transporter) from Albireo AB. Elobixibat will be entering phase 3 trials for CIC and phase 2B trials for IBS-C.
·
Several products are in development for OIC. Seven of those products are mu-opioid receptor antagonists. Progenics Pharmaceuticals, Inc., or Progenics, received FDA approval of methylaltrexone in 2008 for the subcutaneous formulation of this drug in treating opioid bowel dysfunction in patients receiving palliative care. In July 2012, the FDA issued a complete response letter for Salix Pharmaceuticals, Inc., or Salix, and Progenics’ Relistor subcutaneous injection for use in patients with chronic, non-cancer pain; Salix and Progenics are also developing an oral form of Relistor. Salix revealed that the complete response letter was due to a potential cardiovascular class effect related to opioid withdrawal associated with the chronic use of mu-opioid receptor antagonists in patients taking opioids for chronic pain. Salix has appealed this complete response letter and the FDA will be convening an Advisory Committee meeting we believe 1H of 2014.  . Six other companies also have mu-opioid receptor antagonists in development: Nektar Therapeutics and AstraZeneca (naloxegol; phase 3 completed); Cubist Pharmaceuticals (bevenopran; phase 3 initiated); Theravance and GlaxoSmithKline (td-1211; phase 2b completed); S.L.A. Pharma (nalcol; phase 3 completed); and Cosmo Pharmaceuticals (CB-01-16; in phase 1). A fixed dose combination of oxycodone/naloxone (Targin®, Targinact®) is marketed by Mundipharma throughout Europe.
·
Shire is developing a 5-HT4 agonist which is currently in phase 3 for OIC.

RESCULA

RESCULA faces many competitors which promote products for primary open-angle glaucoma, or POAG, and ocular hypertension. Products such as latanaprost, manufactured by Pfizer Inc. became generic in March 2011 which can have a significant impact on the usage of prostaglandins as first line therapy. Other competitive products on the market which also have sales force presence and a focus within the ophthalmic market include travoprost, bimatoprost ophthalmic solution, brimonidine tartrate/timolol maleate ophthalmic solution, brinzolamide ophthalmic suspension, dorzolamide hydrochloride-timolol maleate ophthalmic solution, dorzolamide hydrochloride ophthalmic solution, brimonidine tartrate ophthalmic solution and generic beta blockers. In February 2012, Merck & Co. Inc. received approval for tafluprost ophthalmic solution 0.0015%, a preservative-free prostaglandin analog ophthalmic solution, for reducing elevated IOP in patients with open-angle glaucoma, or OAG, or ocular hypertension. Prostaglandin analogues continue to have significant first line market share followed by generic beta blockers. Other products that are in development for POAG and ocular hypertension include the Rho Kinase inhibitors and Inoteks product which is an adenosine 1 agonist.

 
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Product Candidates

We face similar competition from approved therapies and potential drug products for the diseases and conditions addressed by lubiprostone, unoprostone isopropyl, cobiprostone, and ion channel activators, and are likely to face significant competition for any other product candidates we may elect to develop in the future.

Government Regulation

Government authorities in the United States, at the federal, state and local level, and in other countries extensively regulate the research, development, testing, approval, manufacturing, labeling, post-approval monitoring and reporting, packaging, promotion, storage, advertising, distribution, marketing and export and import of pharmaceutical products such as those we are developing. The process of obtaining regulatory approvals and the subsequent compliance with appropriate federal, state, local and foreign statutes and regulations require the expenditure of substantial time and financial resources.
 
United States Government Regulation
 
In the United States, the FDA regulates drugs under the Federal Food, Drug, and Cosmetic Act, as amended, and implementing regulations. The FDA has jurisdiction over all of our products and administers requirements covering the safety, effectiveness, manufacturing, quality control, distribution, labeling, marketing, advertising, dissemination of information, post-marketing study, and pharmacovigilance of our pharmaceutical products. Information that must be submitted to the FDA in order to obtain approval to market a drug varies depending upon whether the drug is a new product whose safety and efficacy have not previously been demonstrated in humans or a drug whose active ingredients and certain other properties are the same as those of a previously approved drug. The results of product development, preclinical studies and clinical trials must be submitted to the FDA as part of the approval process. The FDA may deny approval if the applicable regulatory criteria are not satisfied, or it may require additional clinical data or analyses or even an additional clinical trial. Even if such data are submitted, the FDA may ultimately decide that the application does not satisfy the criteria for approval.

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

·
Phase 1 consists of safety tests with human clinical evaluations, generally in normal, healthy volunteers;
·
Phase 2 programs expand safety tests and measure efficacy along with dose finding evaluations and are conducted in volunteers with a particular disease condition that the drug is designed to treat; and
·
Phase 3 programs are greatly expanded clinical trials to determine the effectiveness of the drug at a particular dosage level in the affected patient population.

The data from these clinical tests are combined with data regarding chemistry, manufacturing and animal pharmacology and toxicology, and is then submitted in the form of an NDA, to the FDA. The preparation of an NDA requires the expenditure of substantial funds and the commitment of substantial resources.
 
Failure to comply with the applicable FDA requirements at any time during the product development process, approval process or following approval may result in administrative or judicial sanctions. These sanctions could include the FDA’s imposition of a hold on clinical trials, refusal to approve pending applications, withdrawal of an approval, warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties or criminal prosecution. Any agency or judicial enforcement action could have a material adverse effect on us.
 
The FDA extensively regulates all aspects of manufacturing quality under its current Good Manufacturing Practice, or cGMP, regulations. The FDA inspects the facility or the facilities at which drug products are manufactured. The FDA will not approve the product unless cGMP compliance is satisfactory. If the FDA determines the application, manufacturing process or manufacturing facilities, are not acceptable, it will outline the deficiencies in the application and often will request corrective actions including additional validation or information.

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

Post-Approval Requirement
 
After regulatory approval of a product is obtained, we are obligated to comply with a number of post-approval requirements. For example, the FDA may require post marketing, or phase 4 clinical trials to assess additional elements of the product’s safety or efficacy. In addition, holders of an approved NDA are required to report certain adverse drug reactions and production problems to the FDA, to provide updated safety information and to comply with requirements concerning advertising and promotional labeling for their products. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes certain fiscal, procedural, substantive and record-keeping requirements.
 
We rely, and expect to continue to rely, on third parties for the production of clinical and commercial quantities of our drug products at our instruction and on our behalf. Future FDA inspections may identify compliance issues at our facilities or at the facilities of our manufacturers that may disrupt production or distribution, or require substantial resources to correct. In addition, discovery of problems with a product or the failure to comply with applicable requirements may result in restrictions on a product, manufacturer or holder of an approved NDA, including withdrawal or recall of the product from the market or other voluntary, FDA-initiated or judicial action that could delay or prohibit further marketing. Newly discovered or developed safety or effectiveness data may require changes to a product’s approved labeling, including the addition of new warnings, precautions and contraindications. Also, new government requirements, including those resulting from new legislation, may be established that could delay or prevent regulatory approval of our products under development.

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

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

Japan
 
In Japan, pre-marketing approval and clinical studies are required for all pharmaceutical products. The regulatory requirements for pharmaceuticals in Japan have in the past been so lengthy and costly that it has been cost-prohibitive for many pharmaceutical companies. Historically, Japan has required that pivotal clinical data submitted in support of a new drug application be performed on Japanese patients. Recently, however, as a part of the global drug harmonization process, Japan has signaled a willingness to accept United States or E.U. patient data when submitted along with a bridging study, which demonstrates that Japanese and non-Japanese subjects react comparably to the product. This approach, which is executed on a case-by-case basis, may reduce the time required for approval and introduction of new products into the Japanese market. To obtain manufacturing/marketing approval, we must submit an application for approval to the MHLW with results of nonclinical and clinical studies to show the quality, efficacy and safety of a new drug. A data compliance review, GCP on-site inspection, cGMP audit and detailed data review are undertaken by the PMDA. The application is then discussed by the committees of the Pharmaceutical Affairs and Food Sanitation Council, or PAFSC. Based on the results of these reviews, the final decision on approval is made by MHLW. After the approval, negotiations regarding the reimbursement price with MHLW will begin. The price will be determined within 60 to 90 days unless the applicant disagrees, which may result in extended pricing negotiations.

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

·
The federal Medicare and Medicaid Anti-Kickback laws, which prohibit 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, or FCPA, 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;
·
The FCPA 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;
·
The Foreign Corrupt Practices Act, which prohibits certain payments made to foreign government officials;
·
State and foreign law equivalents of the foregoing and state laws regarding pharmaceutical company marketing compliance, reporting and disclosure obligations; and
·
The Patient Protection and Affordable Care Act, or the ACA, which among other things changes access to healthcare products and services; creates new fees for the pharmaceutical and medical device industries; changes rebates and prices for health care products and services; and requires additional reporting and disclosure.

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

Pharmaceutical Pricing and Reimbursement

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

Federal, state and local governments in the United States continue to work towards significant legislation aimed to limit the growth of healthcare costs, including the cost of prescription drugs. Following the United States Supreme Court decision in June 2012 upholding the Patient Protection and Affordable Care Act there has been an increase in the pace of regulatory issuances by those United States government agencies designated to carry out the extensive requirements of the ACA. These regulatory actions have both positive and negative impacts on the United States healthcare industry with much remaining uncertain as to how various provisions of the ACA will ultimately affect the industry. This legislation has both current and long term impacts on us. The provisions of the United States Healthcare Reform Act are effective on various dates over the next several years.

Medicaid is a joint federal and state program that is administered by the states for low income and disabled beneficiaries. Under the Medicaid Drug Rebate Program, we are required to pay a rebate for each unit of product reimbursed by the state Medicaid programs. The amount of the rebate for each product is set by law as the greater of 23.1% of the average manufacturer price, or AMP, or the difference between AMP and the best price available from us to any customer (with limited exceptions). The rebate amount must be adjusted upward if AMP increases more than inflation (measured by the Consumer Price Index - Urban). The adjustment can cause the rebate amount to exceed the minimum 23.1% rebate amount. The rebate amount is calculated each quarter based on our report of current AMP and best price for each of our products to the Centers for Medicare & Medicaid Services. The requirements for calculating AMP and best price are complex. We are required to report any revisions to AMP or best price previously reported within a certain period, which revisions could affect our rebate liability for prior quarters. In addition, if we fail to provide information timely or we are found to have knowingly submitted false information to the government, the statute governing the Medicaid Drug Rebate Program provides for civil monetary penalties.

 
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Medicare is a federal program that is administered by the federal government that covers individuals age 65 and over as well as those with certain disabilities. Medicare Part D provides coverage to enrolled Medicare patients for self-administered drugs (i.e., drugs that do not need to be injected or otherwise administered by a physician). Medicare Part D is administered by private prescription drug plans approved by the United States government and each drug plan establishes its own Medicare Part D formulary for prescription drug coverage and pricing, which the drug plan may modify from time-to-time. The prescription drug plans negotiate pricing with manufacturers and may condition formulary placement on the availability of manufacturer discounts. Manufacturers, including us, are required to provide a 50% discount on brand name prescription drugs utilized by Medicare Part D beneficiaries when those beneficiaries reach the coverage gap in their drug benefits.

Our products are subject to discounted pricing when purchased by federal agencies via the Federal Supply Schedule, or FSS. FSS participation is required for our products to be covered and reimbursed by the Veterans Administration, or VA, Department of Defense, or DoD, Coast Guard, and Public Health Service, or PHS. Coverage under Medicaid, the Medicare Part B program and the PHS pharmaceutical pricing program is also conditioned upon FSS participation. FSS pricing is negotiated periodically with the Department of Veterans Affairs. FSS pricing is intended not to exceed the price that we charge our most-favored non-federal customer for a product. In addition, prices for drugs purchased by the VA, DoD (including drugs purchased by military personnel and dependents through the TriCare retail pharmacy program), Coast Guard, and PHS are subject to a cap on pricing equal to 76.0% of the non-federal average manufacturer price, or non-FAMP. An additional discount applies if non-FAMP increases more than inflation (measured by the Consumer Price Index - Urban). In addition, if we fail to provide information timely or we are found to have knowingly submitted false information to the government, the governing statute provides for civil monetary penalties in addition to other penalties available to the government.

To maintain coverage of our products under the Medicaid Drug Rebate Program, we are required to extend discounts to certain purchasers under the PHS pharmaceutical pricing program. Purchasers eligible for discounts include hospitals that serve a disproportionate share of financially needy patients, community health clinics and other entities that receive health services grants from the PHS.

Regulation Pertaining to Sales and Marketing

We are subject to various federal and state laws pertaining to health care “fraud and abuse,” including anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a prescription drug manufacturer from soliciting, offering, receiving, or paying any remuneration to generate business, including the purchase or prescription of a particular drug. Although the specific provisions of these laws vary, their scope is generally broad and there may be no regulations, guidance or court decisions that clarify how the laws apply to particular industry practices. There is therefore a possibility that our practices might be challenged under the anti-kickback or similar laws. False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented for payment to third party payers (including Medicare and Medicaid), claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services. Our activities relating to the sale and marketing of our products may be subject to scrutiny under these laws. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions, including fines and civil monetary penalties, and exclusion from federal health care programs (including Medicare and Medicaid). Federal and state authorities are paying increased attention to enforcement of these laws within the pharmaceutical industry and private individuals have been active in alleging violations of the laws and bringing suits on behalf of the government under the federal False Claims Act. If we were subject to allegations concerning, or were convicted of violating, these laws, our business could be harmed.

Laws and regulations have been enacted by the federal government and various states to regulate the sales and marketing practices of pharmaceutical manufacturers. The laws and regulations generally limit financial interactions between manufacturers and health care providers or require disclosure to the government and public of such interactions. The laws include federal “sunshine” provisions enacted in 2010 as part of the comprehensive federal health care reform legislation. The sunshine provisions apply to pharmaceutical manufacturers with products reimbursed under certain government programs and require those manufacturers to disclose annually to the federal government (for re-disclosure to the public) certain payments made to physicians and certain other healthcare practitioners or to teaching hospitals. State laws may also require disclosure of pharmaceutical pricing information and marketing expenditures. Many of these laws and regulations contain ambiguous requirements. Given the lack of clarity in laws and their implementation, our reporting actions could be subject to the penalty provisions of the pertinent federal and state laws and regulations. Outside the United States, other countries have implemented requirements for disclosure of financial interactions with healthcare providers and additional countries may consider or implement such laws.

 
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Other Regulations

Foreign Anti-Corruption

We are subject to various federal and foreign laws that govern our international business practices with respect to payments to government officials. Those laws include the United States Foreign Corrupt Practices Act which prohibits United States companies and their representatives from paying, offering to pay, promising, or authorizing the payment of anything of value to any foreign government official, government staff member, political party, or political candidate for the purpose of obtaining or retaining business or to otherwise obtain favorable treatment or influence a person working in an official capacity. In many countries, the health care professionals we regularly interact with may meet the FCPA's definition of a foreign government official. The FCPA also requires public companies to make and keep books and records that accurately and fairly reflect their transactions and to devise and maintain an adequate system of internal accounting controls.

The laws to which we are subject also include the United Kingdom Bribery Act 2010 (Bribery Act) which proscribes giving and receiving bribes in the public and private sectors, bribing a foreign public official, and failing to have adequate procedures to prevent employees and other agents from giving bribes. United States companies that conduct business in the United Kingdom generally will be subject to the Bribery Act. Penalties under the Bribery Act include potentially unlimited fines for companies and criminal sanctions for corporate officers under certain circumstances.

Other Laws

Our present and future business has been and will continue to be subject to various other laws and regulations. Various laws, regulations and recommendations relating to safe working conditions, laboratory practices, the experimental use of animals, and the purchase, storage, movement, import and export and use and disposal of hazardous or potentially hazardous substances used in connection with our research work are or may be applicable to our activities. Certain agreements entered into by us involving exclusive license rights may be subject to national or international antitrust regulatory control, the effect of which cannot be predicted. The extent of government regulation, which might result from future legislation or administrative action, cannot accurately be predicted.
 
Europe
 
Different pricing and reimbursement schemes exist in other countries. In Europe, governments influence the price of pharmaceutical products through their pricing and reimbursement rules and control of national health care systems that fund a large part of the cost of such products to consumers. The approach taken varies from member state to member state. Some jurisdictions permit products to be marketed only after a reimbursement price has been agreed. Other member states allow companies to fix their own prices for medicines, but monitor company profits. In some cases, pharmacoeconomic analyses from clinical studies and other available resources are used to establish pricing using risk-benefit comparisons with currently available products.
 
In the United Kingdom, pharmaceutical companies set their own price and then National bodies (e.g. National Institute for Health and Care Excellence, or NICE), Scottish Medicines Consortium, or SMC), sub-National bodies (e.g. Greater Manchester Medicines Management Group, or GMMMG), London Procurement Partnership, or LPP), or Local bodies (e.g. Clinical Commissioning Groups, or CCGs), Health Boards, or HBs), will determine if a medicine is cost-effective.  The National and sub-National bodies advise local bodies, which are greatly influenced by a NICE endorsement; however, ultimately the decision to pay for a medicine is made at a local level in the United Kingdom.
 
In Switzerland, the Swiss health care system is a compulsory private system where patients pay a monthly variable fee to a registered health insurance fund. All insurers reimburse against a common national formulary, the Specialitätenliste. The BAG makes the decisions on reimbursement and pricing of all prescription drugs in the market with their review taking three to four months. For new drugs it is not uncommon for there to be several rounds of review. It also conducts regular price reviews of the drugs on the formulary. The Federal Commission on drugs or Arzneimittelkommission, or EAK, is a body assisting the BAG with expert advice. Once a product is approved the BAG, in consultation with EAK, decides whether or not the drug will appear on the Specialitätenliste. After EAK’s evaluation of a drug, BAG and EAK decide on the maximum price in the market. The criteria used are:

·
Internal comparison with reimbursed and non-reimbursed therapeutic equivalents,
·
External cross country comparison (reference countries: Denmark, Germany, the United Kingdom and the Netherlands), and
·
Cost benefit analysis

 
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Japan
 
In Japan, pricing is established utilizing various information including reference prices from other international markets. However, the MHLW biannually reviews the pharmaceutical prices of individual products. In the past, these reviews have resulted in price reductions. We expect similar price reviews in the future, in line with the government’s previously announced plan for controlling health care costs. It is not possible to predict the outcome of these reviews, and it is possible that Japanese authorities will again reduce drug reimbursement rates, which could adversely affect the reimbursement levels for our products or product candidates.

Executive Officers

The following table lists our executive officers and their ages as of March 7, 2014.

Name
 
Age
 
Position
Peter Greenleaf
 
44
 
Chief Executive Officer and member of the Board of Directors
         
Cary J. Claiborne
 
53
 
Chief Financial Officer
         
Ryuji Ueno, M.D., Ph.D., Ph.D.
 
60
 
Chief Scientific Officer, Co-Founder and Chairman Emeritus
         
Stanley G. Miele
 
50
 
President, Sucampo Pharma Americas, LLC and Senior Vice President of Sales and Marketing
         
Thomas J. Knapp
 
61
 
Executive Vice President, Chief Legal Officer and Corporate Secretary
 
Peter Greenleaf.  Mr. Greenleaf is our Chief Executive Officer and member, Board of Directors, since March 2014. Prior to his leadership of our company, Mr. Greenleaf was CEO and Board member of Histogenics, a regenerative medicine company, from June 2013 through February 2014. From 2008 to June 2013, Mr. Greenleaf was employed by MedImmune LLC, the global biologics arm of AstraZeneca, where he most recently served as President. While at MedImmune, Mr. Greenleaf was instrumental in driving the expansion of MedImmune's pipeline into over 120 clinical and pre-clinical programs and the commercialization of its marketed products. Mr. Greenleaf also served as President of MedImmune Ventures from January 2010 to June 2013, a wholly owned venture capital fund within the AstraZeneca Group, where he led investment in emerging biopharmaceutical, medical device, and diagnostic companies. Prior to serving as President of MedImmune, Mr. Greenleaf was the Chief Commercial Officer of the company, responsible for its commercial, corporate development and strategy functions. Mr. Greenleaf has also held senior commercial roles at Centocor Biotech, Inc. (now Janssen Biotechnology, Johnson & Johnson) from 1998 to 2006 and prior to that Boehringer Mannheim G.m.b.H. (now Roche Holdings) from 1996 to 1998. Mr. Greenleaf currently chairs the Maryland Venture Fund Authority, whose vision is to oversee implementation of InvestMaryland, a public-private partnership to spur venture capital investment in the state. Mr. Greenleaf is also a member of the board of directors of the Biotechnology Industry Organization (BIO), where he also serves on the Governing Board of the Emerging Companies Section. Mr. Greenleaf's previous Board appointments include the University of Maryland Baltimore Foundation, Inc.; Rib-X Pharmaceuticals; LigoCyte Pharmaceuticals; and Corridor Pharmaceuticals. He received a Masters of Business Administration degree from St. Joseph's University and a Bachelor of Science degree from Western Connecticut State University.

Cary J. Claiborne. Mr. Claiborne joined us March 2011 as Interim Chief Financial Officer until he was promoted to Chief Financial Officer, or CFO, in October 2011. Prior to joining our company, he had been President, CEO, and a member of the board of directors of New Generation Biofuels, Inc., of Columbia, Maryland, a publicly traded biofuel technology company, as well as its CFO since 2007. From December 2004 to November 2007, Mr. Claiborne had been CFO of Osiris Therapeutics, Inc., a stem cell therapeutics company. From December 2001 to June 2004, he was Vice President-Financial Planning & Analysis of Constellation Energy Group. From April 2000 to November 2001, he was VP-Financial Planning & Analysis of The Home Depot, Inc. From July 1997 to March 2000, he was VP-Financial Planning & Analysis at MCI Corporation. He also held a series of progressively more responsible positions in financial management and senior management, including President and CEO of New Enterprise Wholesale Services at GE Capital and GE since 1982. Mr. Claiborne is also a member of the board of directors of MedicAlert Foundation, where he also serves as the chair of the Finance Committee. Mr. Claiborne graduated from Rutgers University where he earned a B.A., Business Administration and an MBA, in Finance, from Villanova University.

Ryuji Ueno, M.D., Ph.D., Ph.D. Dr. Ueno is a founder of our company and has been our Chief Executive Officer, or CEO, from September 2006 through March 2, 2014, and our Chief Scientific Officer since August 2004. Dr. Ueno became the Chairman of our Board of Directors effective June 1, 2007 following the resignation of Dr. Sachiko Kuno from that position, and served in that position until March 2014. Dr. Ueno also served as Chief Operating Officer from December 1996 to November 2000 and again from March 2006 to September 2006 and as Chief Executive Officer from December 2000 to September 2003. Dr. Ueno has been a director since 1996 and served as Chairman of our Board of Directors from December 2000 to September 2006. Dr. Ueno co-founded our affiliate R-Tech in September 1989 and served as its President from 1989 to March 2003. Dr. Ueno also co-founded our wholly-owned subsidiary, Sucampo AG, or SAG, in December 1997 and served as its Chairman of the Board or Vice Chairman of the Board since its inception. Dr. Ueno received his M.D. and a Ph.D. in medicinal chemistry from Keio University in Japan, and he received a Ph.D. in Pharmacology from Osaka University. Dr. Ueno is married to Dr. Sachiko Kuno, one of our founders and a controlling stockholder of S&R Technology Holdings, LLC, or S&R, which owns a majority of our stock.

Stanley G. Miele. Mr. Miele was our Senior Vice President of Sales and Marketing since October 2008 until he was promoted to President of Sucampo Pharma Americas, LLC in September 2009. He had been our Vice President of Sales and National Director of Sales since February 2006. Prior to joining our company as a Sales Director, Mr. Miele managed a national level team of specialty sales representatives and engineering consultants that sold and marketed blood gas analyzers and point of care diagnostic equipment used in acute-care areas within hospitals at Abbott Point of Care beginning in October 2005. Prior to that, Mr. Miele held a series of positions at Millennium Pharmaceuticals and COR Therapeutics, prior to its acquisition by Millennium, including National Sales Director, Cardiology where he was responsible for managing the overall hospital-based cardiovascular sales function beginning January 2003. Previously, Mr. Miele was a Division Sales Representative with Abbott Laboratories’ Hospital Products Division, of Abbott Park, Illinois, and a Sales Representative for Syntex Labs, of Palo Alto, California. Mr. Miele earned a B.A. in Management/Communications from the University of Dayton.

 
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Thomas J. Knapp. Mr. Knapp joined us in February 2010 as Senior Vice President General Counsel and Corporate Secretary until he was promoted to Executive Vice President, Chief Legal Officer and Corporate Secretary in March 2012. Prior to joining our company, he was Of Counsel at Exemplar Law Partners, LLC and a Partner and member at Knapp Law Firm beginning in September 2008. From March 2003 to August 2008, he was Deputy General Counsel and then Vice President, General Counsel and Corporate Secretary at NorthWestern Corporation. From January 2001 to December 2002, Mr. Knapp served as Of Counsel of Paul Hastings, LLP, or Paul Hastings, in Washington, D.C. and from May 1998 to December 2000 as Assistant General Counsel at The Boeing Company in Seattle, Washington. Mr. Knapp also served as Of Counsel of Paul Hastings in Washington, D.C. from May 1996 to April 1998 and he served in various. in-house positions culminating with Labor Counsel at The Burlington Northern & Santa Fe Railway Company, in Chicago, Illinois and Fort Worth, Texas from September 1980 to December 1995. Mr. Knapp earned a B.A. in Political Science at University of Illinois-Urbana and a J.D. at Loyola University of Chicago School of Law.

Employees

As of March 3, 2014, we had 77 full-time employees, including 20 with doctoral or other advanced degrees. Of our workforce, 25 employees are engaged in research and development, 11 are engaged in sales and marketing and 41 are engaged in business development, legal, finance and administration. None of our employees are represented by a labor union or covered by collective bargaining agreements. We have never experienced a work stoppage and believe our relationship with our employees is good.

Research and Development

For information regarding research and development expenses incurred during 2011, 2012 and 2013, see Item 7, “Management Discussion and Analysis of Financial Condition and Results of Operations—Research and Development Expenses”.

Financial Information About Geographic Areas
 
We have determined that we have three reportable segments based on our method of internal reporting, which disaggregates the business by geographic location. These segments are the Americas, Europe and Asia. We evaluate the performance of these segments based primarily on income (loss) from operations, as well as other factors that depend on the growth of these geographies. Such measures include the progress of research and development activities, collaboration and licensing efforts, commercialization activities and other factors.  The financial results of our segments reflect their varying stages of development.

Our Americas segment activities include the commercialization of RESCULA, AMITIZA income and costs associated with the Takeda collaboration.  The segment recorded an income before taxes of $21.0 million in 2013, compared to $11.5 million in 2012, an increase of $9.5 million, or 83.0%.  This increase is primarily attributable to the receipt of the $10.0 million milestone payment from Takeda in 2013 upon the first commercial sale of AMITIZA for OIC.

Our Europe segment activities include the commercialization of AMITIZA in Europe costs associated with pipeline development, intellectual property management and licensing activities. The segment recorded a loss before taxes of $12.4 million in 2013, compared to a loss before taxes of $15.9 million in 2012, a decrease of $3.4 million, or 21.7%.

Our Asia segment activities include the commercialization of AMITIZA in Japan as a result of our collaboration with Abbott.  The segment recorded an income before taxes of $1.8 million in 2013, compared to $12.2 million in 2012, a decrease of $10.4 million, or 85.2%. This decrease is primarily attributable to the milestone payment received from Abbott in 2012.

(In thousands)
 
Americas
   
Europe
   
Asia
   
Consolidated
 
Year Ended December 31, 2013
                       
Total revenues
  $ 73,637     $ 108     $ 15,849     $ 89,594  
Income (loss) before taxes
    20,983       (12,425 )     1,789       10,347  
Identifiable assets
    95,350       23,843       17,780       136,973  
                                 
Year Ended December 31, 2012
                               
Total revenues
  $ 61,026     $ 30     $ 20,431     $ 81,487  
Income (loss) before taxes
    11,463       (15,861 )     12,150       7,752  
Identifiable assets
    87,731       25,465       14,600       127,796  
                                 
Year Ended December 31, 2011
                               
Total revenues
  $ 53,493     $ -     $ 1,268     $ 54,761  
Income (loss) before taxes
    (6,384 )     (10,086 )     (5,444 )     (21,914 )
Identifiable assets
    96,490       47,925       13,154       157,569  

 
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Our Class Capital Structure

On August 30, 2012, we announced that our majority stockholder and only holder of our class B common stock, S&R, had converted effective as of August 29, 2012, all of its 26,191,050 issued and outstanding shares of our class B common stock into shares of our class A common stock. S&R held all of our outstanding class B common stock. Class B common stock holders were entitled to ten votes per share while class A common stock holders were entitled to one vote per share. Our Articles of Incorporation permit the holder of class B common stock to convert the shares of class B common stock into shares of class A common stock at any time and on a one-for-one basis. As a result of the conversion, there is now only a single class of outstanding common stock, class A common stock, which is entitled to one vote per share.

Our Corporate Information

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

The following is a list of our direct and indirect subsidiaries as of December 31, 2013:

Subsidiary
 
State or other jurisdiction of incorporation or organization
Sucampo Pharma Americas, LLC
 
Delaware
     
Sucampo LLC
 
Delaware
     
Sucampo AG
 
Switzerland
     
Sucampo Pharma, Ltd.
 
Japan
     
Sucampo Pharma Europe Ltd.
 
United Kingdom
     
Ambrent Investments S.à r.l.
 
Luxembourg

Our principal executive offices are located at 4520 East-West Highway, 3rd Floor, Bethesda, Maryland 20814, and our telephone number is (301) 961-3400.

Website Access to United States Securities and Exchange Commission Reports

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

Before deciding to purchase, hold or sell our common stock, you should carefully consider the risks described below in addition to the other cautionary statements and risks described elsewhere and the other information contained in this report and in our other filings with the SEC, including subsequent Quarterly Reports on Forms 10-Q and Current Reports on Form 8-K. We operate in a rapidly changing environment that involves a number of risks. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. These known and unknown risks could materially and adversely affect our business, financial condition, prospects, operating results or cash flows.

Risks Related to Our Business and Industry

If we are unable to successfully commercialize and develop products in a very competitive market, our business and results of operations will be materially adversely affected.
 
The pharmaceutical industry is highly competitive. To be successful, we must be able to, among other things, effectively discover, develop, test and obtain regulatory approvals for products. We or our partners must be able to effectively commercialize, market and promote approved products, including communicating the effectiveness, safety and value of products to actual and prospective customers and medical professionals. Many of our competitors have greater resources than we have. This enables them, among other things, to make greater research and development investments, as well as increased levels of marketing and promotional expenditures.

Developments by our competitors, the entry of new competitors into the markets in which we compete, or consolidation in the pharmaceutical industry could make our products or technologies less competitive or obsolete. Our future growth depends, in part, on our ability to develop and introduce products which are more effective than those developed by our competitors. Royalties or sales from our existing products may decline rapidly if a new product is introduced that represents a substantial improvement over our existing products.

Our future success depends upon our ability to develop new products, and new indications for existing products, that achieve regulatory approval for commercialization.

For our business model to be successful, we must continually develop, manufacture and commercialize new products or achieve new indications or label extensions for the use of our existing products. Prior to commercialization, these new products and product indications must satisfy stringent regulatory standards and receive requisite approvals or clearances from regulatory authorities in the United States and other countries. The development, regulatory review and approval, and commercialization processes are time consuming, costly and subject to numerous factors that may delay or prevent the development, approval or clearance, and commercialization of new products, including legal actions brought by our competitors. To obtain approval or clearance of new indications or products, we must submit, among other information, the results of preclinical and clinical studies on the new indication or product candidate to the applicable regulatory authorities. The number of preclinical and clinical studies that will be required for regulatory approval varies depending on the regulatory authority, the new indication or product candidate, the disease or condition for which the new indication or product candidate is in development and the regulations applicable to that new indication or product candidate. Even if we believe that the data collected from clinical trials of new indications for our existing products or for our product candidates are promising, the regulatory authority may find such data to be insufficient to support approval of the new indication or product. The regulatory authority can delay, limit or deny approval or clearance of a new indication or product candidate for many reasons, including:

·
the new indication or product candidate is not safe or effective;
·
our preclinical and clinical data is interpreted in different ways than we interpret that data;
·
we may be required to perform post-marketing clinical studies; or
·
there may be changes in the approval policies or adoption of new regulations.

Products that we are currently developing, other future product candidates or new indications or label extensions for our existing products, may or may not receive the regulatory approvals or clearances necessary for marketing or may receive such approvals or clearances only after delays or unanticipated costs.

Our product, AMITIZA, faces competition from competitors’ products like linaclotide, which, in addition to other factors, could in certain circumstances lead to a significant reduction in royalty revenues and product sales. Our other product, RESCULA, faces competition from other competitors’ products, which, in addition to other factors, could lead to a significant reduction in product sales.

 
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Our products, AMITIZA and RESCULA, face competition from competitors’ products. Specifically, AMITIZA faces competition from linaclotide which was recently approved for two of the three indications that AMITIZA has been approved in the U.S and for IBS-C in certain European countries. Its manufacturer is seeking approval in other markets for IBS-C that we currently or intend to market AMITIZA. Linaclotide may be safer or more effective or more effectively marketed and sold than AMITIZA is by our partners or by ourselves. Similarly, RESCULA faces competition from other competitors’ products which could be more effective, have better customer access or be more effectively marketed and sold. Alternatively, in the case of generic competition, including the generic availability of competitors’ branded products, they may be equally safe and effective products that are sold at a substantially lower price than our products. As a result, if we fail to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial position and prospects.

We are transitioning from a predominantly research and development company. As we build our own commercial capabilities we will continue to rely on certain third parties for the successful commercialization of some of our drug products. The success of these third parties as well as our own commercialization efforts will affect our ability to continue to develop new drug candidates. Our own commercial success will affect our ability to reduce our reliance on the performance of these third parties.

For most of our operating history, we have been a research and development company. As we move from a predominately R&D company, our operations will focus on organizing and staffing our company, building the necessary infrastructure to support commercialization, developing prostone technology, undertaking preclinical and clinical trials of our product candidates, pursuing the regulatory approval processes for additional indications for AMITIZA and RESCULA, and commercializing AMITIZA and RESCULA. Though we will continue to rely upon the collaboration agreement with Takeda and Abbott to commercialize AMITIZA in the United States and Japan, we may not be able to cause these third parties to effectively market and sell AMITIZA. While we are currently utilizing R-Tech to perform the manufacturing functions and rely on Takeda and Abbott to perform many of the sales and marketing functions with respect to the sale of AMITIZA in the in the United States and Japan, we may nevertheless encounter unforeseen expenses, difficulties, complications and delays as we establish these commercial functions for AMITIZA and RESCULA 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 lubiprostone and unoprostone isopropyl, and to pursue regulatory approvals for lubiprostone, unoprostone isopropyl and other products outside the United States, it could be difficult for us to access capital, to build the necessary infrastructure, to obtain and devote the resources necessary to successfully manage our commercialization efforts, to effectively market and sell our products, and to generate the assets to support commercialization of our products.

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 March 2010, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, or ACA, was enacted in the United States. In 2012 the United States Supreme Court upheld the ACA. This legislation may have both immediate and long-term impacts on us.  A number of the provisions of those laws require rulemaking action by governmental agencies to implement, many of which have not yet occurred. The laws change access to health care products and services and create new fees for the pharmaceutical and medical device industries. Future rulemaking could increase rebates, reduce prices or the rate of price increases for health care products and services, or require additional reporting and disclosure. We cannot predict the timing or impact of any future rulemaking.

If we are unable to continue successful commercialization of AMITIZA and RESCULA for the approved indications and other indications for which we are developing these drugs, or experience significant delays in doing so, our ability to generate product-based revenues and achieve profitability will be jeopardized.

In the near term, our ability to increase product-based revenues will depend on the continued growth in commercialization by ourselves, Takeda and Abbott of AMITIZA, our commercialization of RESCULA, and our continued development of AMITIZA and RESCULA. The growth in sales of AMITIZA and RESCULA will depend on several factors, including the following:

·
the best efforts of Takeda and Abbott to commercialize and maximize net sales revenue of AMITIZA;
·
our ability to commercialize and maximize net sales revenue of AMITIZA and RESCULA;
·
our ability to complete clinical trials and secure additional indications for lubiprostone;
·
the ability of R-Tech, which has the exclusive right to manufacture and supply AMITIZA, or any substitute manufacturer to supply quantities of AMITIZA sufficient to meet market demand and at acceptable levels of quality and price;
·
continued and growing acceptance of AMITIZA and RESCULA within the medical community and by third-party payers;
·
successful completion of clinical trials of AMITIZA for the treatment of other constipation-related gastrointestinal indications beyond CIC, IBS-C and OIC, and successful commercialization of these indications within and outside the United States;
·
successful development and commercialization of RESCULA; and
 
 
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·
receipt of marketing approvals from the FDA and similar foreign regulatory authorities for additional indications for AMITIZA and RESCULA.

We may generate growth through acquisitions and in-licensing and such strategy may not be successful if we are not able to identify suitable acquisition or licensing candidates, to negotiate appropriate 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 for our existing products and to complement our existing product pipeline. We have limited experience in completing acquisitions with third parties as well as performing under in-licensing agreements and we may not be able to identify appropriate acquisition or licensing candidates or to successfully negotiate the terms of any such transaction. The licensing and acquisition of pharmaceutical and biological products is a competitive area. A number of more established companies are also pursuing strategies to license or acquire products in the pharmaceutical field, and they may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities. If we are unable to successfully complete acquisitions or in-licensing transactions for suitable products and product candidates, our prospects for growth could suffer.

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

Risks Related to Our Commercial Operations

Any acquisitions we make could disrupt our business and seriously harm our financial condition.

We may, from time to time, consider acquisitions of complementary companies, products or technologies. Acquisitions involve numerous risks, including difficulties in the assimilation of the acquired businesses, the diversion of our management’s attention from other business concerns and potential adverse effects on existing business relationships with current customers and suppliers. In addition, any acquisitions could involve the incurrence of substantial additional indebtedness. We cannot assure you that we will be able to successfully integrate any acquisitions that we pursue or that such acquisitions will perform as planned or prove to be beneficial to our operations and cash flow. Any such failure could seriously harm our business, financial condition and results of operations.

The acquisition of SAG in December 2010 resulted in the issuance of two subordinated unsecured promissory notes in the aggregate amount of approximately $51.9 million. The outstanding balance on the notes as of December 31, 2013 was $33.7 million. If we do not generate sufficient cash flows from our operations, we may not be able to pay the obligations of the notes on a timely basis, which may adversely affect our operating results. Our failure to comply with the covenants and/or obligations related to the notes could result in an event of default, which could result in an immediate acceleration of the outstanding balance of the notes that could materially and adversely affect our operating results and our financial condition. As of December 31, 2013, we were compliant.

Although we have reported profit in 2013, we may not maintain operating profitability in the future, and this could force us to delay, reduce or abandon our commercialization efforts or product development programs.

Although we have reported net income in 2013, this was primarily attributable to increased product royalties and product sales under our agreements with Takeda and Abbott. We recorded a net income of $6.4 million and $4.8 million in 2013 and 2012, respectively. Our primary cost drivers result from expenses incurred in our research and development programs and from our commercialization, 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, conduct development of the prostone technology, seek regulatory approvals for additional indications and additional territories for AMITIZA and for other drug candidates, and commercialize AMITIZA and RESCULA. Whether we are able to achieve sustainable operating profitability in commercialization of AMITIZA outside of the United States and Canada and RESCULA within and outside of the United States, our future will depend upon our ability to generate revenues that exceed our expenses and to access sufficient capital. Changes in market conditions, including the failure or approval of competing products, may require us to incur more expenses or change the timing of expenses such that we may incur unexpected losses. We may not be able to sustain or increase profitability on a quarterly or annual basis. If we are unable to maintain profitability, the market value of our class A common stock may decline.

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.

 
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We expect our research and development expenses as well as our commercialization 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 continued to finance much of our operations by payments received under our collaboration agreements with Takeda and Abbott and milestone and other payments from R-Tech. We believe that our existing cash and cash equivalents and internally generated funds that we anticipate from AMITIZA product sales will be sufficient to enable us to fund our operating expenses under the collaboration agreements with Takeda and Abbott but not for future research and development programs. Our future funding requirements, however, will depend on many factors, including:

·
actual levels of product royalty from AMITIZA;
·
actual levels of AMITIZA and RESCULA product sales;
·
increasing the workforce;
·
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 qualified human 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 Abbott;
·
the success of our commercialization efforts of AMITIZA and RESCULA; 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 at-the-market sales, public or private equity offerings, debt financings or corporate collaboration and licensing arrangements. If we raise additional funds by at-the-market sales or issuing equity securities, current stockholders may experience dilution. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights and related intellectual property to our technologies, research programs, products or product candidates.

We are developing internationally and increasing our foreign operations; therefore, we have an increased exposure to foreign political conditions and regulatory requirements and fluctuations in foreign currency exchange rates.

We expect that we will continue to expand our international operations in the future. International operations inherently subject us to a number of risks and uncertainties, including:

·
changes in international regulatory and compliance requirements that could restrict our ability to manufacture, market and sell our products;
·
political and economic instability;
·
diminished protection of intellectual property in some countries outside of the United States;
·
trade protection measures and import or export licensing requirements;
·
difficulty in staffing and managing international operations;
·
differing labor regulations and business practices;
·
potentially negative consequences from changes in or interpretations of tax laws;
·
changes in international medical reimbursement policies and programs;
·
financial risks such as longer payment cycles, difficulty collecting accounts receivable and exposure to fluctuations in foreign currency exchange rates; and
·
regulatory and compliance risks that relate to maintaining accurate information and control over sales and distributors’ and service providers’ activities that may fall within the purview of the Foreign Corrupt Practices Act.

Any of these factors may, individually or as a group, have a material adverse effect on our business and results of operations.
 
As we expand our existing international operations, we may encounter new risks. For example, as we focus on building our business in new geographic regions, we must continue to develop relationships with qualified local distributors and trading companies. If we are not successful in developing and maintaining these relationships, we may not be able to grow revenue in these geographic regions. These or other similar risks could adversely affect our revenue and profitability.

 
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Risks Related to Product Pipeline

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 and commercialize the prostone pipeline will be impaired, which may jeopardize our business.

Before obtaining regulatory approval for the sale of our product candidates from the prostone pipeline, 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, is subject to varying regulatory requirements 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;
·
clinical research organizations we retain to conduct clinical trials may not perform according to the terms of the contract, causing delays or negative results in the clinical trials;
·
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;
·
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;
·
we face competition from approved therapies and potential drug products for the diseases and conditions addressed by unoprostone isopropyl, cobiprostone and ion channel activators, and are likely to face significant competition for any other product candidates we may elect to develop in the future;
·
many of our competitors 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 and smaller or early stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies; 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.

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 may perform additional clinical trials for other indications or in support of applications for regulatory marketing approval in jurisdictions outside the United States for our products. These supplemental trials could be costly and could result in findings inconsistent with or contrary to our historic United States clinical trials.

 
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In the future, we may be required, or we may elect, to conduct additional clinical trials of AMITIZA or RESCULA to improve the current label or address regulatory authorities concerns about AMITIZA or RESCULA. In addition, if we seek marketing approval from regulatory authorities in jurisdictions outside the United States, such as the EMA, they may require us to perform additional clinical trials that would be costly and difficult to know if there will be successful outcomes and to submit data from supplemental clinical trials in addition to data from the clinical trials that supported our United States 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 the existing marketing approval for AMITIZA or RESCULA or could force us to stop selling AMITIZA or RESCULA. Inconsistent trial results could also lead to delays in obtaining marketing approval in the United States for other indications for AMITIZA, RESCULA or for other product candidates and 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.

Risks Related to Employees and Managing Growth

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

We have been highly dependent on Dr. Ryuji Ueno, as chief scientific officer, for the development of the prostone technology and the other principal members of our executive and scientific teams to successfully manage the growth of our company. Dr. Ueno will step down as our chief scientific officer to be a consultant for us in 2014. The loss of the services of Dr. Ueno as a full-time chief scientific officer and any of the scientific 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 consultant agreements and employment agreements with these executives and scientific persons, but these agreements are terminable by the consultants and employees on short or no notice at any time without penalty to the consultant or employee.

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, RESCULA 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  RESCULA 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 AMITIZA, RESCULA, cobiprostone and ion channel activators 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 and RESCULA to meet our commercial and clinical requirements throughout the world and we do not have an alternative source of supply for AMITIZA and RESCULA. We also do not have an alternative source of supply for cobiprostone or ion channel activators, which R-Tech manufactures and supplies to us. If R-Tech is not able to supply AMITIZA, RESCULA 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 and RESCULA would be significantly impaired and our development programs could be seriously jeopardized. R-Tech has relocated its manufacturing facility for RESCULA beginning October 2012 and will not be able to manufacture and supply unoprostone isopropyl for up to 18 months. R-Tech has informed us that it is contracting with NittoMedic to manufacture RESCULA. In order to mitigate this risk, we had placed an order to sufficiently cover this supply period based on our forecasts.  R-Tech delivered that order to us in the first quarter of 2013. However, the NittoMedic facility was required to be inspected by FDA. That inspection has resulted in NittoMedic receiving notice of deficiencies and us receiving a complete response letter for the sNDA. NittoMedic has responded to the FDA and we have asked the FDA to review the sNDa in light of the NittoMedic response.  The FDA has indicated it will do so and we are awaiting FDA’s decision.

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;
 
 
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·
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. 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.

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

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

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

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

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

A key element of our business strategy is to collaborate where appropriate with third parties, particularly leading pharmaceutical companies, to co-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 co-development and commercialization of AMITIZA for gastrointestinal indications in the United States and Canada. While we have experienced significant difficulties with Takeda’s performance under that agreement, we are working with Takeda to improve the performance of the commercialization activities under that agreement. We are also party to an agreement with Abbott for the development and commercialization of AMITIZA in Japan.

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

·
our agreements with Takeda and Abbott are, and any future collaboration agreements that we may enter into are likely to be, subject to termination under various circumstances;
 
 
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·
Takeda, Abbott 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, Abbott 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, Abbott 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, Abbott and other future collaborators may change the focus of their development and commercialization efforts.

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

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, or CROs, 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 IBS-C. We use multiple CROs 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.

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 cGCP, 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 R-Tech and us, and these conflicts might ultimately be resolved in a manner unfavorable to us.

Our founders, Dr. Sachiko Kuno and Dr. Ryuji Ueno, together own a majority of the stock of R-Tech. Drs. Kuno and Ueno are married to each other. Ownership interests of our founders in the stock of R-Tech, and Dr. Ueno’s service as a consultant to our company providing certain scientific and other services may 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 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, RESCULA, cobiprostone and ion channel activators;
·
a decision whether to engage R-Tech in the future to manufacture and supply compounds other than AMITIZA, RESCULA, cobiprostone and ion channel activators;
·
a decision whether to renegotiate the terms of our existing agreements with R-Tech or a strategic acquisition with R-Tech; or
·
business opportunities unrelated to prostones that may be attractive both to us and to the other company.

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

We are a member of an affiliated group of entities, including R-Tech, which is directly or indirectly controlled by Drs. Ueno and Kuno. We have had and will continue to have significant commercial transactions with these entities. Furthermore, we operate four foreign subsidiaries, Sucampo Pharma, Ltd., or SPL, based in Tokyo and Osaka, Japan; Sucampo Pharma Europe, Ltd., or SPE, based in Oxford, United Kingdom; SAG, based in Zug, Switzerland; and Ambrent Investments S.à r.l., based in Luxembourg. We expect to operate through a consolidated organizational structure and we expect to enter into commercial transactions with some of these entities or future subsidiaries on an ongoing basis. As a result of these transactions, we will be subject to complex transfer pricing and other tax regulations in both the United States and the other countries in which we and our affiliates operate. Transfer pricing regulations generally require that, for tax purposes, transactions between our subsidiaries and affiliates and us be priced on a basis that would be comparable to an arm’s length transaction and that contemporaneous documentation be maintained to support the related party agreements. To the extent that United States or any foreign tax authorities disagree with our transfer pricing or other policies, we could become subject to significant tax liabilities and penalties related to prior, existing and future related party agreements. As of December 31, 2013, we performed updated tax analyses wherein liabilities for uncertain tax positions were recorded for certain state jurisdictions based on nexus related to the sourcing of revenues. Should the tax authorities in one or more of these states have different interpretations than us, we may be subject to additional tax liabilities.

 
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Risks Related to Our Intellectual Property

As a result of receiving a notification from generic companies that an Abbreviated New Drug Application was filed, we have recently initiated a patent infringement lawsuit against those generic companies. 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 adversely affected.

Our success depends in part on our ability 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 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 R-Tech instead of issued patents, and we do not know whether these patent applications will result in the issuance of any patents. Our licensed patents have recently been challenged for lubiprostone through the filing of an Abbreviated New Drug Application by generic companies and other licensed patents may be challenged, invalidated or circumvented, which could limit the term of patent protection for lubiprostone or our other products, diminish our ability to stop competitors from marketing related products, and materially adversely affect our business and results of operations. We filed a patent infringement lawsuit against the generic companies and if we are not successful in that lawsuit, we may not be able to stop the generic companies from entering the market. We have certain patents on our products that expire in the near future. We may not be able to use other existing patents or patent applications to successfully protect our products from generic competition. 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 R-Tech’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 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.

Patents 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 R-Tech can be certain whether a judicial court will uphold the validity of a patent.

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 or appropriate pricing for a product candidate will prevent us from commercializing the product candidates.

As we increase our foreign operations we are seeking and will continue to seek approval in different territories. Different regulatory agencies may reach different decisions in assessing the approval and pricing of our product candidates. Securing regulatory approval requires the submission of extensive preclinical and clinical data, information about product manufacturing processes and inspection of facilities and supporting information to the regulatory agencies for each therapeutic indication to establish the product candidate’s safety and efficacy. Our future products may not be effective, may be only moderately effective or may prove to have undesirable side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use.

The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon the type, complexity and novelty of the product candidates involved. Changes in the regulatory approval policy during the development period, changes in or the enactment of additional statutes or regulations, or changes in regulatory review for each submitted product application, may cause delays in the approval or rejection of an application. The FDA and foreign regulatory agencies have 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.

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

Regulatory authorities in some jurisdictions, including Europe and the United States, may designate drugs that target relatively small patient populations as orphan drugs. We have received an orphan drug designation from the FDA for our product candidate cobiprostone for the treatment of disorders associated with cystic fibrosis. We have also received orphan drug designation for unoprostone Isopropyl from the FDA and EMA for the treatment of retinitis pigmentosa. We may pursue orphan drug designation for additional product candidates. Generally, if a product with an orphan drug designation subsequently receives the first marketing approval for the indication for which it has such designation, the product is entitled to a period of marketing exclusivity. The exclusivity applies only to the indication for which the drug has been designated and approved. The applicable exclusivity period is seven years in the United States, but this period may be interrupted if a sponsor of a competitive product that is otherwise the same drug for the same use can show that its drug is clinically superior to our orphan drug candidate. The European exclusivity period is ten years, but may be reduced to six years if a drug no longer meets the criteria for orphan drug designation, including where it is shown that the drug is sufficiently profitable so that market exclusivity is no longer justified. In addition, European regulations establish that a competitor’s marketing authorization for a similar product with the same indication may be granted if there is an insufficient supply of the product or if another applicant can establish that its product is safer, more effective or otherwise clinically superior. If a competitor obtains orphan drug exclusivity for a product competitive with cobiprostone or unoprostone isopropyl before we do and if the competitor’s product is the same drug with the same indication as ours, we would be excluded from the market, unless we can show that our drug is safer, more effective or otherwise clinically superior. Even if we obtain orphan drug exclusivity for cobiprostone or unoprostone isopropyl 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;
·
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;
·
the Foreign Corrupt Practices Act, which prohibits certain payments made to foreign government officials;
·
state and foreign law equivalents of the foregoing and state laws regarding pharmaceutical company marketing compliance, reporting and disclosure obligations; and
·
the Patient Protection and Affordable Care Act, which changes access to healthcare products and services; creates new fees for the pharmaceutical and medical device industries; changes rebates and prices for health care products and services; and requires additional reporting and disclosure.

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.

 
31

 
Risks Related to Our Common Stock

Our founders maintain the ability to control all matters submitted to stockholders for approval, which could result in actions of which you or other stockholders do not approve.

Our founders, Dr. Ryuji Ueno, our chief scientific officer, and Dr. Sachiko Kuno, together through their direct or indirect interest in S&R Technology Holding, LLC beneficially own 26,190,255 shares of class A common stock, representing approximately 59.5% of the combined voting power of our outstanding common stock as of March 3, 2014. As a result, Drs. Ueno and Kuno, who are married, acting by themselves, are able to control the outcome of all matters that our stockholders vote upon, including the election of directors, amendments to our certificate of incorporation, and mergers or other business combinations. The concentration of ownership and voting power also may have the effect of delaying or preventing a change in control of our company and could prevent stockholders from receiving a premium over the market price if a change in control is proposed.

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

There are provisions in our certificate of incorporation and by-laws that may make it difficult for a third party to acquire, or attempt to acquire, control of our company, even if a change in control was considered favorable by you and other stockholders. For example, our Board of Directors has the authority to issue up to 5.0 million 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 of the conversion of class B common stock to class A common stock in August 2012, the board of directors is now a staggered board. 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:

·
as a result of the August 2012 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;
·
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 75.0% 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; common stock. These provisions may also prevent changes in our management. Because of these provisions, the value of our common stock may be materially adversely affected.

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

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

·
failure of AMITIZA, RESCULA 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;
·
the success of competitive products or technologies;
·
regulatory developments in the United States and foreign countries;
 
 
32

 
·
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.

ITEM 1B.  UNRESOLVED STAFF COMMENTS.

None.

ITEM 2.     PROPERTIES.

Our corporate headquarters, including our principal executive office, and some of our commercial, administrative and research and development activities, are located in Bethesda, Maryland. Our lease for this facility, which comprises approximately 25,000 square feet of office space, expires in February 2017.

We lease our Asian offices located in Tokyo and Osaka, Japan and European office, located in Zug, Switzerland, under short-term leases, which comprise an aggregate of 5,950 square feet of space.

ITEM 3.     LEGAL PROCEEDINGS

On January 2, 2013, we received a first Notice Letter and on January 25, 2013, we received a second Notice Letter from Anchen and Par regarding their filing of an Abbreviated New Drug Application with the FDA to market a generic version of AMITIZA oral capsules, 8 mcg and 24 mcg. On February 8 2013, we announced that we, along with R-Tech and Takeda, filed a patent infringement lawsuit in the United States District Court for the District of Delaware against Anchen and Par. The lawsuit claims infringement of six patents that are listed in the FDA’s Orange Book and that are scheduled to expire between 2020 and 2027. Subsequently, we, along with R-Tech and Takeda, amended the lawsuit to add allegations in respect to an additional Notice Letter received from Anchen and Par which Notice Letter responded to an additional patent listed on the FDA’s Orange Book. The parties have initiated written discovery and the District Court has entered a scheduling order. Depositions of the inventors and other fact witnesses will take place in the second and third quarter of 2014, with the trial starting in December 2014.

ITEM 4.     MINE SAFETY DISCLOSURES

Not applicable.
 
 
33

 
PART II

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

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

Quarters Ended
 
High
   
Low
 
March 31, 2012
  $ 7.64     $ 4.25  
June 30, 2012
  $ 8.44     $ 6.73  
September 30, 2012
  $ 6.95     $ 3.88  
December 31, 2012
  $ 6.07     $ 4.48  
March 31, 2013
  $ 6.54     $ 4.77  
June 30, 2013
  $ 10.04     $ 6.14  
September 30, 2013
  $ 7.00     $ 5.62  
December 31, 2013
  $ 9.47     $ 6.09  

As of March 3, 2014, we had 43,998,430shares of class A common stock outstanding held by 12 stockholders of record. The number of holders of record of our class A common stock is not representative of the number of beneficial holders because many shares are held by depositories, brokers or nominees. As of March 3, 2014, the closing price of our class A common stock was $8.49.

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

The information regarding the securities authorized for issuance under our equity compensation plan is incorporated into this section by reference from the section captioned “Equity Compensation Plan Information” in our Proxy Statement.

Issuer Purchases of Equity Securities.

On December 11, 2008, we announced a stock repurchase program approved by our Board of Directors to purchase up to $10.0 million of our class A common stock from time to time in open-market transactions. On September 8, 2011, we announced that our Board of Directors authorized the repurchase of up to an aggregate of $2.0 million of our class A common stock out of the $10.0 million approved. On November 2, 2012, our Board of Directors authorized the increase of such amount of repurchase to up to an aggregate of $5.0 million.

During the fourth quarter ended December 31, 2013, we did not repurchase any of our equity securities. During the twelve months ended December 31, 2013, we repurchased 67,762 shares of our class A common stock under this program at a cost of $336,000.

Issuer Sales of Equity Securities

As previously disclosed, on January 11, 2013, we entered into a sales agreement with Cantor Fitzgerald & Co., or Cantor Sales Agreement, which enables us to offer and sell shares of our class A common stock with aggregate class A common stock sales  of up to $20.0 million, from time to time through Cantor Fitzgerald & Co. as our sales agent. Sales of class A common stock under the Cantor Sales Agreement are made in sales deemed to be “at-the-market” equity offerings as defined in Rule 415 promulgated under the Securities Act of 1933, as amended. Cantor Fitzgerald & Co. is entitled to receive a commission rate of 3.0% of gross sales in connection with the sale of our class A common stock sold on our behalf. From November 22, 2013 through December 31, 2013, we sold through the Cantor Sales Agreement an aggregate of 749,383 shares of our class A common stock, and received gross proceeds of approximately $5.3 million, before deducting issuance expenses.

Stock Performance Graph

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

 
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The following graph compares the cumulative total return, assuming the investment of $100 on December 31, 2008, in each of (1) our class A common stock, (2) The NASDAQ Composite Index (United States and Foreign) and (3) the NASDAQ Biotechnology Index, assuming reinvestment of any dividends. These comparisons are required by the SEC and are not intended to forecast or be indicative of possible future performance of our class A common stock.


 
35

 
ITEM 6.     SELECTED FINANCIAL DATA

The following derived consolidated financial data as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 are from our audited Consolidated Financial Statements appearing elsewhere in this Annual Report. The following consolidated financial data as of December 31, 2011, 2010 and 2009 and for the years ended December 31, 2010 and 2009 are derived from audited Consolidated Financial Statements not included in this Annual Report. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related footnotes appearing elsewhere in this Annual Report on Form 10-K.

   
Year Ended December 31,
 
(In thousands, except per share data)
 
2013
   
2012
   
2011
   
2010
   
2009
 
Statement of operations data
                             
Revenues
  $ 89,594     $ 81,487     $ 54,761     $ 61,870     $ 67,351  
Costs and expenses:
                                       
Cost of goods sold
    12,402       3,030       -       -       -  
Research and development
    21,524       21,292       33,497       23,955       32,906  
Settlement of legal dispute
    -       -       (11,100 )     -       -  
General and administrative
    25,413       30,157       41,270       27,867       15,000  
Selling and marketing
    21,059       18,691       8,783       10,201       10,030  
Total costs and expenses
    80,398       73,170       72,450       62,023       57,936  
Income (loss) from operations
    9,196       8,317       (17,689 )     (153 )     9,415  
Total non-operating income (expense), net
    1,151       (565 )     (4,225 )     (3,167 )     446  
Income (loss) before income taxes
    10,347       7,752       (21,914 )     (3,320 )     9,861  
Income tax benefit (provision)
    (3,928 )     (2,916 )     4,608       565       (5,084 )
Net income (loss)
  $ 6,419     $ 4,836     $ (17,306 )   $ (2,755 )   $ 4,777  
Basic net income (loss) per share
  $ 0.15     $ 0.12     $ (0.41 )   $ (0.07 )   $ 0.11  
Diluted net income (loss) per share
  $ 0.15     $ 0.12     $ (0.41 )   $ (0.07 )   $ 0.11  
Weighted average common shares outstanding - basic
    41,716       41,660       41,839       41,848       41,844  
Weighted average common shares outstanding - diluted
    42,544       41,785       41,839       41,848       41,866  
Per Share Data
                                       
Income (loss) from operations-basic
  $ 0.22     $ 0.20     $ (0.42 )   $ (0.00 )   $ 0.23  
Income (loss) from operations-diluted
  $ 0.22     $ 0.20     $ (0.42 )   $ (0.00 )   $ 0.22  
                                         
 
   
December 31,
 
(In thousands)
    2013       2012       2011       2010       2009  
Balance sheet data:
                                       
Cash and cash equivalents
  $ 44,102     $ 52,022     $ 50,662     $ 49,243     $ 61,420  
Investments, current
    16,003       6,035       24,452       54,524       72,434  
Working capital
    70,741       52,843       67,835       94,541       127,313  
Total assets
    136,973       127,796       157,569       149,273       180,005  
Notes payable, current
    26,892       19,129       20,400       19,522       -  
Notes payable, non-current
    25,828       33,722       39,227       44,439       -  
Total liabilities
    78,825       84,766       118,975       95,443       34,693  
Retained earnings (accumulated deficit)
    (27,681 )     (34,100 )     (38,936 )     (21,630 )     33,150  
Total stockholders' equity
    58,148       43,030       38,594       53,830       145,312  
 
 
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ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Overview

We are a global biopharmaceutical company focused on innovative research, discovery, development and commercialization of proprietary drugs based on ion channel activators known as prostones. The therapeutic potential of prostones was first discovered by our co-founder, Dr. Ryuji Ueno. He initially found that that prostone production was high in early development, and postulated that prostones produced by 15-PGDH may play important roles as an endogenous local hormones in maturation and aging. Under his leadership we have pioneered the field of prostones. Prostones are naturally occurring fatty acid metabolites which were originally thought to be biologically inert. Prostones have emerged as a promising compound class with unique physiological activities which can be targeted for the treatment of unmet or underserved medical needs.

We have two approved products, AMITIZA® (lubiprostone) and RESCULA® (unoprostone isopropyl). Our strategic priorities are as follows: for AMITIZA, to increase sales in the United States, Japan and Europe, to expand into new indications, and to launch into new global markets; for RESCULA, to continue to commercialize the product to current prescribers in the United States, and to expand into new indications with unoprostone isopropyl; and to further develop our late-stage clinical development compounds.

First, in the United States, AMITIZA is being marketed and developed under a collaboration and license agreement with Takeda Pharmaceutical Company Limited, or Takeda, for gastrointestinal indications. In Japan, AMITIZA is being marketed under a collaboration agreement with Abbott Japan Co. Ltd., or Abbott. AMITIZA is also approved and currently being commercialized in the United Kingdom and Switzerland for chronic idiopathic constipation, or CIC. We have plans to file for approval in other European markets. Our priorities for AMITIZA are to increase sales of the product in markets where it is approved; to obtain approval of AMITIZA for other indications in certain European markets; to expand into new global markets; and to develop AMITIZA in a liquid formulation and for the pediatric market. We began clinical development for the liquid formulation and pediatric dosage in the second half of 2013.

Second, RESCULA received approval of a sNDA by the FDA in December 2012, and in the first quarter of 2013 we launched the product within the ophthalmology and optometry communities. This launch marks the first time we have commercialized a product in the United States on our own.
 
Third, a final priority for us is the development of our prostone-based pipeline. In 2013, we furthered our clinical development of three drug candidates:  the intravenous and oral ion channel activators for lumbar spinal stenosis and cobiprostone for oral mucositis.

We currently generate revenue mainly from product royalties, development milestone payments, clinical development activities and product sales. We expect to continue to incur significant expenses for the next several years as we continue our research and development activities, seek additional regulatory approvals for additional indications for AMITIZA, RESCULA and other compounds, and commercialize our approved products (as discussed below) on a global basis.

Our operations are conducted through subsidiaries based in Japan, the United States, Switzerland, the United Kingdom and Luxembourg. Our reportable geographic segments are Asia, the Americas and Europe and we evaluate the performance of these segments based primarily on income (loss) from operations, as well as other factors that depend on the growth of these segments. Such measures include the progress of research and development activities, collaboration and licensing efforts, commercialization activities and other factors.

Our Prostone Products, Approved and in Clinical Development

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

AMITIZA (lubiprostone)

United States

In April 2013, we received approval for a supplemental new drug application, or sNDA, for AMITIZA at dosage strength of 24 micrograms twice daily as the first and only oral medication for the treatment of OIC in adult patients with chronic, non-cancer pain. Upon the first commercial sale of AMITIZA for OIC, we recognized a $10.0 million milestone payment from Takeda as revenue, which we received in the second quarter of 2013. In November 2013, we announced that we are exercising our co-promotion option and will begin co-promoting AMITIZA for OIC in adults with chronic, non-cancer pain in the first quarter of 2014.
 
 
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Japan

In Japan, AMITIZA is currently marketed under a license, commercialization and supply agreement, or the Abbott Agreement, with Abbott for the gastrointestinal indication of chronic constipation, or CC, excluding constipation caused by organic diseases. Abbott initiated commercial sales of AMITIZA in Japan for the treatment of CC in November 2012. AMITIZA is Japan’s only prescription medicine for CC. On December 1, 2013, the two-week limitation on prescriptions, generally applied to all new approvals of products for the first year after reimbursement price approval, was removed.
 
Europe
 
We have retained full rights to develop and commercialize AMITIZA ourselves for the rest of the world’s markets outside of the United States, Canada and Japan. In the United Kingdom, AMITIZA was approved for CIC in July 2012. We made AMITIZA available in the United Kingdom in the fourth quarter of 2013. We filed for the OIC indication in Switzerland in the first quarter of 2013, and we anticipate a decision in the first half of 2014. On March 7, 2014 MHRA notified us that the application for approval of the OIC indication in the United Kingdom was not approved, and we are considering the appropriate next steps with MHRA. We are also considering seeking approval for AMITIZA in other European Union countries following the Mutual Recognition Procedure, or MRP. We are currently working to achieve National Institute for Health and Care Excellence endorsement for CIC. In February 2012, we announced we are actively marketing AMITIZA in Switzerland. In February 2014, we announced that the BAG revised several limitations with which AMITIZA was first approved for reimbursement and inclusion in the specialitätenliste, or SL, to make it easier for all Swiss physicians to prescribe AMITIZA to patients who have failed previous treatments with at least two laxatives over a nine month period. The SL limitations that were revised are:
 
·
All Swiss physicians, not just gastroenterologists, are now allowed to prescribe AMITIZA;
·
The change in the maximum treatment duration of AMITIZA increased from 12 to 52 weeks before a review is needed by a health insurance health care practitioner; and
·
The BAG removed from AMITIZA’s SL a group limitation pertaining to the number of AMITIZA packs that physicians can prescribe at one time.
 
Other Global Markets
 
We and Takeda are currently exploring the commercialization of AMITIZA in Canada and we have met with Health Canada to discuss the best ways to proceed with AMITIZA registration in this market in the near future.
 
We continue to explore options to develop and commercialize AMITIZA in other geographic regions, inclusive of Latin America, Russia, the Middle East and other Asian countries. In the People’s Republic of China, we continue to evaluate development and potential commercialization of lubiprostone.
 
RESCULA (unoprostone isopropyl)
 
We began commercializing RESCULA in February 2013 in the United States. According to the United States approved product labeling, RESCULA may be used as a first-line agent or concomitantly with other topical ophthalmic drug products to lower IOP. RESCULA is a big potassium channel activator and has a different mechanism of action than other IOP lowering agents on the market.
 
We are also evaluating the opportunities in the European Union and other European countries to commercialize unoprostone isopropyl there. In addition, we are co-developing unoprostone isopropyl with R-Tech and may file for FDA and EMA approval for the treatment of RP in the future assuming successful trials.
 
During the third quarter of 2013, we recorded a $4.5 million non-cash write-off of its RESCULA inventory to reflect anticipated excess quantities of dated product consisting of $3.0 million of product for sale and $1.5 million of sample inventory. The anticipated excess inventory was largely a result of the necessity to pre-order product in advance of FDA approval due to a planned change in manufacturing facility and lower than anticipated sales within the useful life of the dated product. Beginning in January 2014, we significantly decreased the amount of in-person sales calls for RESCULA by using a contract sales force to focus its detailing on current prescribers. We also use a limited mix of inside sales and other promotional tactics, including digital, to reach the current non-prescriber base in an effort to increase prescribers and sales of RESCULA.
 
Our Other Clinical Development Programs
 
 
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Lubiprostone
 
Liquid Formulation
 
In October 2013, we announced the initiation of a pivotal trial of a liquid formulation of lubiprostone 24mcg twice daily in adults with CIC. Upon reviewing the results of this trial, which we anticipate to end in the first half of 2014, we plan to file a new drug application for approval.
 
Pediatric Functional Constipation
 
In December 2013, we announced the initiation of the pivotal phase 3 clinical program for AMITIZA in pediatric functional constipation. This is the first of a series of global, multicenter phase 3 studies to evaluate the efficacy, safety, and pharmacokinetics of lubiprostone in patients aged ≥ 6 months through 17 years of age with pediatric functional constipation. The program will consist of two randomized, placebo-controlled, double-blinded studies and two long-term safety extension studies. One of the pediatric trials will also use the liquid formulation.
 
Unoprostone Isopropyl
 
Retinitis Pigmentosa

In October 2013, we announced that our development partner, R-Tech, completed patient enrollment of a phase 3 clinical trial for unoprostone isopropyl for retinitis pigmentosa, or RP, in Japan. A substantial portion of the development costs for the program are being funded by the Japan Science and Technology Agency. We have the rights to the clinical data for potential filing in Europe and the United States, where unoprostone isopropyl has orphan drug designation, and will decide on our path forward assuming the Japanese trial is successful. Additionally, we are currently evaluating opportunities in other retinal diseases, such as age-related macular degeneration.

Intravenous (IV) and Oral (PO) Ion Channel Activators

Lumbar Spinal Stenosis

We have both an IV ion channel activator and a PO ion channel activator in development for the treatment of lumbar spinal stenosis, or LSS. In December 2013, we reported results of the treatment phase of our phase 2a, double-blind, placebo-controlled study of the IV version of our ion channel activator for LSS, that indicated statistically significant improvement in Visual Analog Scale pain. We plan to initiate an additional phase 2a in the second half of 2014. The PO ion channel activator for phase 1a clinical development results were reported in August 2013 and demonstrated to be generally well-tolerated. We plan to initiate the next phase of clinical development in the first quarter of 2014. Additionally, these compounds may be investigated for other indications.

Cobiprostone

Oral spray for Oral Mucositis

Cobiprostone is in development for the target indication of prevention and/or treatment of oral mucositis, or OM. In August 2013, we reported results of our phase 1a trial for the oral spray formulation of cobiprostone that demonstrated the compound is to be generally well-tolerated in healthy volunteers. In October 2013, we initiated a phase 1b clinical development study, which is expected to conclude in the first half of 2014.

Financial Terms of our License, Commercialization and Supply Agreement with Abbott

Upfront Payment

Upon signing the Abbott Agreement in February 2009, we received a non-refundable upfront payment of $10.0 million.

Product Development Milestone Payments

We have received the following non-refundable payments from Abbott reflecting our achievement of specific product development milestones:

·
$7.5 million upon the initiation of the phase 3 clinical trial for lubiprostone for the treatment of CIC in Japanese patients in May 2009;
 
 
39

 
·
$5.0 million as a result of submission of a marketing application to the PMDA for AMITIZA at dosage strength of 24 micrograms for the indication of CIC in October 2010; and
·
$15.0 million as a result of first commercial sale of AMITIZA at dosage strength of 24 micrograms in Japanese adults in November 2012.

There can be no assurances that we will receive additional development or commercial milestone payments under our agreement with Abbott.

Product Revenue

We purchase and assume title to inventories of AMITIZA and recognize revenues from the sales, to Abbott, of such product when earned.

Abbott Cash Flows and Revenue

The following table summarizes the cash streams and related revenue recognized or deferred under the license, commercialization and supply agreement with Abbott:

   
Cash
Received 
Through
December 31,
   
Revenue Recognized for the
Year Ended December 31,
   
Accounts
Receivable
for the Year
Ended
December 31,
   
Foreign
Currency
   
Amount
Deferred at
December 31,
 
(In thousands)
 
2013
   
Through 2011
   
2012
   
2013
   
2013
   
Effects
   
2013
 
Collaboration revenue:
                                         
Up-front payment associated with the Company's obligation to participate in joint committees
  $ 846     $ 137     $ 52     $ 52     $ -     $ 50     $ 555  
                                                         
Research and development revenue:
                                                 
Up-front payment - remainder
  $ 9,154     $ 9,103     $ 199     $ -     $ -     $ (148   $ -  
Development milestone payment
    27,500       12,598       15,157       -       -       (255     -  
Total
  $ 36,654     $ 21,701     $ 15,356     $ -     $ -     $ (403   $ -  
                                                         
                                                         
Product sales revenue:
  $ 19,017     $ -     $ 5,023     $ 15,807     $ 2,076     $ 263     $ -  
 
 
 
Financial Terms of our License and Collaboration Agreement with Takeda
 
 
Upfront Payment

Upon signing the Takeda Agreement in October 2004, we received a non-refundable upfront payment of $20.0 million.

Product Development Milestone Payments

We have 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 CIC in March 2005;
·
$20.0 million upon the initiation of our phase 3 clinical trial related to AMITIZA for the treatment of IBS-C in May 2005;
·
$20.0 million upon the receipt of approval from the FDA for AMITIZA for the treatment of CIC in adults of both genders and all ages in January 2006;
·
$30.0 million upon the filing of the sNDA for AMITIZA to the FDA seeking marketing approval for AMITIZA for the treatment of IBS-C in June 2007;
·
$50.0 million upon the receipt of approval from the FDA for AMITIZA for the treatment of IBS-C in women aged 18 years and older in May 2008; and
·
$10.0 million upon the commercial sale of AMITIZA for OIC in the second quarter of 2013.
 
Research and Development Cost-Sharing for AMITIZA

Our Takeda Agreement and Supplemental Takeda Agreement provides for the sharing with Takeda the costs of our research and development activities for AMITIZA in the United States and Canada as follows:

Research and development expense related to AMITIZA for the treatment of CIC and IBS-C:

 
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·
Any additional research and development expense in excess of $50.0 million shall be shared equally between Takeda and us. As of December 31, 2013, the related aggregate research and development expense incurred was $45.8 million.
·
For research and development expenses relating to changing or expanding the labeling of AMITIZA to treat CIC and IBS-C, Takeda is responsible for 70% of these expenses and we are responsible for 30%. Through December 31, 2013, we had incurred $2.4 million of these expenses, of which we were reimbursed approximately $1.6 million by Takeda.
·
The expense of ongoing and future clinical development of AMITIZA for the treatment of pediatric functional constipation will be borne by Takeda up to 70%. As of December 31, 2013, we had incurred $10.5 million of these expenses, 70% of which have been or are to be reimbursed by Takeda.
·
For expenses in connection with additional clinical trials required by regulatory authorities relating to AMITIZA to treat CIC or IBS-C, Takeda and we are responsible to share these expenses equally. We have not incurred any expenses of this nature to date.

Research and development expense related to AMITIZA for the treatment of gastrointestinal indications other than CIC and IBS-C:

·
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 CIC and IBS-C, and any expenses in excess of $50.0 million are shared equally between Takeda and us. We conducted clinical trials of AMITIZA for the treatment of OIC. Through December 31, 2013, we had incurred $78.6 million of reimbursable 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. Through December 31, 2013, we have incurred $4.5 million of expenses to date relating to liquid formulation.

Co-Promotion Expense Reimbursements
 
In connection with the Supplemental Takeda Agreement (which co-promotion expense reimbursement provision expired in May 2011) and the Takeda Agreement, Takeda agreed to reimburse a portion of our expenses related to our specialty sales force. We recognized $61,000, $3.6 million and $3.4 million of co-promotion revenue reflecting these reimbursements for the years ended December 31, 2013, 2012 and 2011, respectively. In 2013, our sales force shifted away from selling AMITIZA, which was partially reimbursed by Takeda, to selling RESCULA. In November, 2013, we announced that we would be exercising our co-promotion option and will begin co-promoting AMITIZA for OIC in adults with chronic, non-cancer pain in the first quarter of 2014. Takeda will reimburse us under the Takeda Agreement for those product details made by our contract sales force of healthcare professionals.

Product Royalty Revenue

Takeda is obligated to pay us a sliding royalty rate based on a percentage of the net sales revenue from the sale of AMITIZA in the United States and Canada. The actual percentage depends on the level of net sales revenue attained each calendar year. All sales of AMITIZA in the United States and Canada, including those arranged by our specialty sales force, are made through Takeda. AMITIZA is currently marketed only in the United States and during the years ended December 31, 2013, 2012 and 2011 we recognized a total of $52.1 million, $50.7 million and $41.5 million, respectively, as product royalty revenue.

Commercialization Milestone Payments

Our agreements also require Takeda to pay us up to an additional aggregate of $50.0 million upon the achievement of specified targets for annual net sales revenue from AMITIZA in the United States and Canada. Sales of AMITIZA have not met these targets as of December 31, 2013.
 
 
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Takeda Cash Flows and Revenue

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

   
Cash
Received 
Through
December 31,
   
Revenue Recognized for the
Year Ended December 31,
   
Accounts
Receivable
for the Year
Ended
December 31,
   
Amount
Deferred at
December 31,
 
(In thousands)
 
2013
   
Through 2011
   
2012
   
2013
   
2013 (1)
   
2013
 
Collaboration revenue:
                                   
Up-front payment associated with
                                   
the Company's obligation to
                                   
participate in joint committees
  $ 2,375     $ 1,052     $ 147     $ 147     $ -     $ 1,029  
                                                 
Research and development revenue:
                                               
Up-front payment - remainder
  $ 17,624     $ 17,624     $ -     $ -     $ -     $ -  
Development milestones
    140,000       130,000       -       10,000       -       -  
Reimbursement of research and
                                               
development expenses
    114,670       100,262       6,189       10,354       2,554       419  
Total
  $ 272,294     $ 247,886     $ 6,189     $ 20,354     $ 2,554     $ 419  
                                                 
Product royalty revenue
  $ 276,598     $ 188,631     $ 50,696     $ 52,100     $ 14,829     $ -  
                                                 
Co-promotion revenue
  $ 29,453     $ 25,816     $ 3,576     $ 61     $ -     $ -  
_______
(1)      Includes billed and unbilled accounts receivable.

Financial Terms of our Supply Agreement with R-Tech

Under the exclusive supply agreement with R-Tech, R-Tech has the exclusive right to manufacture and supply lubiprostone in the United States and Canada, and in consideration for such rights R-Tech agreed to pay us as follows: $1.0 million upon execution of the agreement and $2.0 million upon commencement of a first phase 2 lubiprostone trial. Upon execution of the agreement, we had already commenced phase 2 clinical trials for lubiprostone, which resulted in an immediate payment of $3.0 million ?V $1.0 million for the agreement execution and $2.0 million for the commencement of the first phase 2 lubiprostone trial. We evaluated the total cash receipts of $6.0 million from R-Tech and determined the payments were made for the exclusive right to supply inventory to us and determined that the amounts should be deferred until commercialization of the drug begins since this is the point at which the underlying services would commence. Management determined that the full deferred amount would be amortized over the contractual life of the relationship which was equivalent to the estimated commercialization period of lubiprostone (estimated to be through December 2020).

As previously reported, we ceased development of another prostone, RUG-015, in 2005. This changed the amortization period of the $6.0 million deferred revenue to the commercialization period of AMITIZA, which began in April 2006. We recognized revenue of $419,000 for the years ended December 31, 2013 and 2012, respectively, which is recorded as contract revenue. During the years ended December 31, 2013, 2012 and 2011, we purchased clinical supplies from R-Tech of approximately $827,000, $1.4 million and $72,000, respectively, under the terms of this agreement.

Under the exclusive manufacturing and supply agreement with R-Tech to manufacture and supply lubiprostone for clinical and commercial supplies within Europe, there have been no clinical supply purchases in 2013, 2012 or 2011. During the years ended December 31, 2013, 2012 and 2011, we purchased approximately zero, $124,000 and $125,000, respectively, of commercial supplies of lubiprostone from R-Tech in anticipation of a commercial launch in Europe.

Under the two-year, automatic renewal exclusive clinical manufacturing and supply agreement with R-Tech for cobiprostone and ion channel activators, no purchases were made for such clinical supplies during the years ended December 31, 2013, 2012 and 2011.

We entered into an exclusive supply arrangement with R-Tech under which we granted R-Tech the exclusive right to manufacture and supply lubiprostone to meet its commercial and clinical requirements in Asia, Australia and New Zealand. During the years ended December 31, 2013, 2012 and 2011, we purchased approximately $14.9 million, $3.1 million and $166,000, respectively, of commercial supplies of lubiprostone from R-Tech under this agreement. During the years ended December 31, 2013 and 2012, we purchased approximately $673,000 and $10,000, respectively, of clinical supplies from R-Tech under this agreement. There were no such clinical supplies purchased in 2011 from R-Tech under this agreement.

 
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In April 2009, we entered into an agreement with R-Tech to acquire rights to RESCULA in the United States and Canada. Under the terms of the agreement, we hold the exclusive rights to commercialize RESCULA in the United States and Canada for its approved ophthalmic indication and any new indication developed by us. Under the terms of the agreement, we made an upfront payment of $3.0 million and may be required to pay up to $5.5 million in additional milestone payments to R-Tech based on the achievement of specified development and commercialization goals. The first milestone payment of $500,000 was paid to R-Tech in the first quarter of 2013 upon the re-launch of RESCULA for the treatment of glaucoma.

Under the terms of the 2011 agreement, we may be required to pay up to $100.0 million in additional milestone payments to R-Tech based on the achievement of specified development and commercialization goals. Through December 31, 2013, we made milestone payments to R-Tech of $6.0 million, including $3.0 million in the first quarter of 2012, which are reflected in other non-current assets in the accompanying Consolidated Balance Sheets.

We have also made purchases for other research and development services during the years ended December 31, 2013, 2012, and 2011 of approximately $194,000, $466,000 and $104,000, respectively.

In March 2012, R-Tech informed us that it was relocating its manufacturing facility for unoprostone isopropyl beginning October 2012, and will not be able to manufacture and supply unoprostone isopropyl for up to 18 months. R-Tech designated another facility in Japan, but such facility would need to be inspected by the FDA in 2013 before it can manufacture unoprostone isopropyl.  In order to mitigate this risk, we placed an order of approximately $5.3 million to cover this supply period based on our forecasts for the launch of RESCULA in the United States. R-Tech commenced delivery of that order to us in the first and second quarters of 2013. Such facility has been inspected by the FDA in the fourth quarter of 2013, and the FDA issued a notice of deficiencies to contractor of the new facility.  The FDA also issued a complete response letter to us concerning the drug master file. The new contractor has responded and we requested FDA to review the sNDA, which it has agreed to do. We are awaiting the decision of the FDA.

We recorded the following expenses under all of our agreements with R-Tech:

   
Year Ended December 31,
 
(In thousands)
 
2013
   
2012
   
2011
 
Clinical supplies
  $ 827     $ 1,450     $ 72  
Other research and development services
    194       466       104  
Commercial supplies
    14,902       3,288       155  
    $ 15,923     $ 5,204     $ 331  
 
Critical Accounting Policies and Estimates

This discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with generally accepted accounting principles in the United States The preparation of our Consolidated Financial Statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses. Actual results may differ significantly from those estimates under different assumptions and conditions.
 
We regard an accounting estimate or assumptions 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 2 of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.

Revenue Recognition

Collaboration and License Agreements

Our revenues are derived primarily from collaboration and license agreements and include upfront payments, development milestone payments, reimbursements of development and co-promotion costs, product royalties and product sales.

 
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We evaluated the multiple deliverables within our joint collaboration and license agreements to determine whether the delivered elements that are our obligation have value to other parties to the agreement on a stand-alone basis and whether objective reliable evidence of fair value of the undelivered items exists. Deliverables that meet these criteria are considered a separate unit of accounting. Deliverables that do not meet these criteria are combined and accounted for as a single unit of accounting. The appropriate recognition of revenue is then applied to each separate unit of accounting.

In October 2009, the FASB issued new revenue recognition standards for arrangements with multiple deliverables, which were effective for us as of January 1, 2011. These standards address the determination of the unit(s) of accounting for multiple-element arrangements and how the arrangement’s consideration should be allocated to each unit of accounting. An item can generally be considered a separate unit of accounting if all of the following criteria are met: (1) the delivered item(s) has value to the customer on a stand-alone basis and (2) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in control of us. Items that cannot be divided into separate units are combined with other units of accounting, as appropriate. Consideration received is allocated among the separate units based on vendor-specific objective evidence, or VSOE, if available; third-party evidence, if VSOE is unavailable; and estimated selling prices if neither VSOE nor third-party evidence is available. The new accounting standards were adopted by us on a prospective basis on January 1, 2011. We did not enter into any new multiple-element arrangements or materially modify any existing arrangements during 2011. However, we initiated new research and development studies after January 1, 2011, that are being reimbursed by Takeda and are treated as separate elements within the Takeda Agreement.

Where agreements include contingent milestones we evaluate whether each milestone is substantive. Milestones are considered substantive if all of the following conditions are met: (1) it is commensurate with either our performance to meet the milestone or the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the our performance to achieve the milestone, (2) it relates solely to past performance, and (3) the value of the milestone is reasonable relative to all the deliverables and payment terms (including other potential milestone consideration) within the arrangement.  Where milestones are not considered substantive their treatment is based on either a time-based or proportional performance model.

We apply a time-based model of revenue recognition for cash flows associated with research and development deliverables entered into prior to January 1, 2011, under the Takeda Agreement. Under this model, cash flow streams related to each unit of accounting are recognized as revenue over the estimated performance period. Upon receipt of cash payments, such as development milestones, revenue is recognized to the extent the accumulated service time has occurred. The remainder is deferred and recognized as revenue ratably over the remaining estimated performance period. A change in the period of time expected to complete the deliverable is accounted for as a change in estimate on a prospective basis. In cases where milestone payments are received after the completion of the associated development period, we recognize revenue upon completion of the performance obligation. Revenue is limited to amounts that are nonrefundable and that the other party to the agreement is contractually obligated to pay to us. The research and development revenue for these obligations is limited to the lesser of the actual reimbursable costs incurred or the straight-line amount of revenue recognized over the estimated performance period. Revenues are recognized for reimbursable costs only if those costs can be reasonably determined.

For research and development deliverables agreed upon subsequent to January 1, 2011 which are reimbursable by Takeda at contractually predetermined percentages, we recognize revenue when the underlying research and development expenses are incurred, assuming all other revenue recognition criteria are met.

We apply a proportional-performance model using the percentage-of-completion method of revenue recognition for cash flows associated with research and development deliverables under the Abbott Agreement. Since we have previous research and development experience and the expected cost to complete the development can be reasonably estimated, we believe a proportional-performance methodology of revenue recognition is appropriate. Under this method, revenue in any period is recognized as a percentage of the total actual cost expended relative to the total estimated costs required to satisfy the performance obligations under the arrangement. Revenue recognized is limited to the amounts that are non-refundable and that the other party to the agreement is contractually obligated to pay us. A change in the period of time expected to complete the deliverable is accounted for as a change in estimate on a prospective basis. Research and development costs are not reimbursable under the Abbott Agreement. The milestone recognized and received in 2012 was considered a substantive milestone.

Under the Takeda Agreement, royalties are based on net sales of licensed products and are recorded on the accrual basis when earned in accordance with contractual terms when third-party results are reliably measurable, collectability is reasonably assured and all other revenue recognition criteria are met.
 
Takeda reimbursements of co-promotion costs under the Supplemental Takeda Agreement (which co-promotion expense reimbursement provision expired in May 2011) and the Takeda Agreement, 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 Takeda Agreement and, as such, we record reimbursements of these amounts on a gross basis as co-promotion revenue.

 
44

 
Product sales consist of AMITIZA sales to Abbott in Japan and by us in Europe and RESCULA in the United States. Revenue from product sales is recognized when persuasive evidence of an arrangement exists, delivery has occurred and title to product and associated risk of loss have passed to the customer, the price is fixed or determinable, collection from the customer is reasonably assured. We do not record sales deductions and returns for sales of AMITIZA to Abbott due to the absence of discounts and rebates and no right of return under the contract with Abbott. We recognize revenue from RESCULA product sales less deductions for estimated sales discounts and sales returns. We account for rebates to certain governmental agencies as a reduction of product sales. We allow customers to return product within a specified time period prior to and subsequent to the product’s labeled expiration date. As a result, we estimate an accrual for product returns, which is recorded as a reduction of product sales. Given our limited history of selling RESCULA and the return period, we cannot reasonably estimate product returns from the wholesale distribution channel. Therefore, we are deferring the recognition of revenue until there is confirmation of pull-through sales to end-user customers. We will continue to defer recognition until the point at which we have obtained sufficient sales history to reasonably estimate returns from the wholesalers.

We recognize contract revenue related to development and commercialization activities under the time-based method over the applicable period.

We consider our participation in the joint committees under the Takeda and Abbott Agreements as separate deliverables under the contracts and recognize the fair value of such participation as revenue over the period of the participation per the terms of the contracts.

We have determined that we are acting as a principal under both the Takeda Agreement and Abbott Agreement and, as such, record revenue on a gross basis in the Consolidated Statements of Operations and Comprehensive Income (Loss), except in regards to selling product under the Takeda agreement where we recorded product royalty revenue.

Accrued Research and Development Expenses
 
As part of our process of preparing our Consolidated Financial Statements, we are required to estimate an accrual for research and development expenses. This process involves reviewing and identifying services which have been performed by third parties on our behalf and determining the value of these services. Examples of these services are payments to clinical investigators and CRO’s. In addition, we make estimates of costs incurred to date but not yet invoiced to us in relation to external CROs and clinical site costs. We analyze the progress of clinical trials, including levels of patient enrollment; invoices received and contracted costs, when evaluating the adequacy of the accrued liabilities for research and development. We must make significant judgments and estimates in determining the accrued balance in any accounting period. No material adjustments have been required for this accrual during the years ended December 31, 2013 and 2012.

Stock-Based Compensation

We estimate the fair value of share-based payment awards on the date of the grant using an option-pricing model and recognize the expense over the required service periods.

For recording our stock-based compensation expense, for service based and market condition options we have chosen to use:

·
the straight-line method of allocating compensation cost for service based options and graded vesting for market condition options;
·
the Black-Scholes-Merton option pricing formula for time based options and the Monte Carlo simulation model for the market condition options as our chosen option-pricing models;
·
the simplified method to calculate the expected term for options as discussed under the SEC’s guidance for share-based payments for service based options; and
·
an estimate of expected volatility based on the historical volatility of similar entities whose share prices are publicly available.

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.

 
45

 
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 the Financial Accounting Standards Board or, FASB’s, guidance for accounting for income taxes which 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, stock compensation, and the transfer of intellectual property 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, expiration dates of net operating loss carry-forwards, and prudent and feasible tax planning strategies in determining the need for a valuation allowance. Considerable judgment is involved in developing such estimates. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, we would charge an adjustment to earnings for the deferred tax assets in the period in which we make that determination. Likewise, if we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance. In order for us to realize our deferred tax assets we must be able to generate sufficient taxable income in the tax jurisdictions in which our deferred tax assets are located.

Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance recorded against our net deferred tax assets in certain jurisdictions. Significant future events, not under our control, including continued success in commercialization of products in United States markets or regulatory approvals for products in international markets, could affect our future earnings potential and consequently the amount of deferred tax assets that will be utilized.

During 2011, we transferred certain intellectual property and licenses to SAG. Since the transfer of these assets was to a subsidiary, the recognition of a deferred tax asset by SAG is prohibited and the net tax effect of the transaction is deferred in consolidation. The deferred tax liability generated from this transaction is offset by a deferred charge that will be amortized over ten years. As of December 31, 2013, the total deferred charge is $5.2 million after a net current year amortization expense of $673,000.

As of December 31, 2013 and 2012, we had foreign net operating loss, or NOLs, carry forwards of $11.9 million and $21.0 million, respectively. Approximately $7.0 million of the foreign NOL begin to expire in December 2019, and $4.9 million of the foreign NOLs do not expire.

We followed the FASB’s guidance for uncertainty in income taxes that requires the application of a “more likely than not” threshold to the recognition and de-recognition of uncertain tax positions. If the recognition threshold is met, this guidance permits us to recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is more than 50.0% percent likely to be realized upon settlement.

We recognize interest and penalties accrued related to uncertain tax positions as a component of the income tax provision. The liability for uncertain tax positions as of December 31, 2013 mainly pertains to our interpretation of nexus in certain states related to certain revenue sources for state income tax purposes. The amount expected to reverse within the next twelve months as a result of prior period settlements with state tax authorities has been recorded as a current liability. Other than the expected settlement, no other uncertain tax positions have been identified for which it is reasonably possible that the total amount of liability for unrecognized tax benefits will significantly increase or decrease within 12 months, except for recurring accruals on existing uncertain tax positions.

Related Party Transactions

As part of our operations, we may enter into transactions with our affiliates or other parties we determine as related and such transactions may include sales and purchases of product, borrowing and lending. At the time of each 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 affiliates, we have evaluated the terms of transactions to be similar to those that would have prevailed had the entities not been affiliated.
 
 
Results of Operations

Comparison of years ended December 31, 2013 and December 31, 2012

 
46

 
Revenues

The following table summarizes our revenues for the years ended December 31, 2013 and 2012:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2013
   
2012
 
Research and development revenue
  $ 20,354     $ 21,545  
Product royalty revenue
    52,100       50,696  
Product sales revenue
    16,425       5,037  
Co-promotion revenue
    61       3,576  
Contract and collaboration revenue
    654       633  
Total
  $ 89,594     $ 81,487  
 
Total revenues were $89.6 million in 2013 compared to $81.5 million in 2012, an increase of $8.1 million, or 9.9%.

Research and development revenue

Research and development revenue was $20.4 million in 2013 compared to $21.5 million in 2012, a decrease of $1.2 million or 5.5%. The decrease was primarily due to the receipt of lower milestone payments in 2013 compared to 2012. In 2012 we received a $15.0 million milestone payment from Abbott upon the first commercial sale of AMITIZA in Japan and in 2013 we received a $10.0 million milestone payment from Takeda upon the first commercial sale of AMITIZA for OIC. Excluding the milestone payments, research and development revenue was $10.4 million in 2013 compared to $6.5 million in 2012, an increase of $3.9 million or 58.2%, due primarily to lubiprostone studies of liquid formulation and pediatric dosage.

 
Product royalty revenue

Product royalty revenue represents royalty revenue earned on net sales of AMITIZA in the United States, as reported to us by our partner, Takeda. In 2013, we recognized $52.1 million of product royalty revenue compared to $50.7 million in 2012, an increase of $1.4 million or 2.8%. The increase was due to higher Takeda reported AMITIZA net sales that were primarily driven by higher prices.

 
Product sales revenue

Product sales revenue represents drug product net sales of AMITIZA in Japan and Switzerland and RESCULA in the United States. Product sales revenue in 2013 and 2012 was $16.4 million and $5.0 million, respectively, an increase of $11.4 million or 226.1%.  The increase was primarily due to the growth of product sales of AMITIZA in Japan, which commenced in the fourth quarter of 2012 and the commencement of product sales of RESCULA in the United States and AMITIZA in Switzerland during the first quarter of 2013

Co-promotion revenue

Co-promotion revenue represents reimbursements by Takeda of a portion of our co-promotion costs for our specialty sales force. In 2013, we recognized $61,000 of co-promotion revenue compared to $3.6 million in 2012, a decrease of $3.6 million, or 100%.  The decrease in co-promotion revenue was the result of our sales force shifting away from selling AMITIZA, which was partially reimbursed by Takeda, to selling RESCULA.
 
 
Cost of Goods Sold

Cost of goods sold relates to purchase and distribution costs of our products sold by us, including inventory write-offs for excess and obsolete inventory and amortization of marketing licenses. Cost of goods sold was $12.4 million and $3.0 million in 2013 and 2012, respectively, an increase of $9.4 million, or 309.3%. The increase in cost of goods sold relates to increased drug product sales of AMITIZA in Japan and Switzerland, and RESCULA in the United States. Additionally, during the third quarter of 2013, we recorded a $3.0 million write-off of RESCULA inventory to reflect anticipated excess quantities of dated product. The anticipated excess inventory was largely a result of the necessity to pre-order product in advance of FDA approval due to a planned manufacturer shutdown and lower than anticipated sales within the useful life of the dated product. In addition to initial sales falling below their forecast, in the fourth quarter of 2013 we decided to eliminate our in-house sales force and deploy a contract sales force to detail only current RESCULA prescribers at a much reduced level, which will further impact future sales of RESCULA.
 
 
47

 
 
Research and Development Expenses

The following summarizes our research and development expenses for the years ended December 31, 2013 and 2012:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2013
   
2012
 
Direct costs:
           
Lubiprostone
  $ 10,644     $ 8,311  
Cobiprostone
    1,269       2,019  
Ion channel activator
    2,738       581  
Unoprostone isopropyl
    1,060       2,819  
Other
    2,912       5,179  
Total
    18,623       18,909  
                 
Indirect costs
    2,901       2,383  
Total
  $ 21,524     $ 21,292  
 
Total research and development expenses in 2013 were $21.5 million compared to $21.3 million in 2012, an increase of $232,000, or 1.1%. The increase in research and development expenses was primarily due to the higher costs associated with lubiprostone pediatric and liquid formulation, our clinical development of the lumbar spinal stenosis program, and higher indirect costs including regulatory fees; these increases were partially offset by lower costs associated with our development programs for cobiprostone and lubiprostone isopropyl and terminated Numab collaboration.
 
 
General and Administrative Expenses

The following summarizes our general and administrative expenses for years ended December 31, 2013 and 2012:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2013
   
2012
 
Salaries, benefits and related costs
  $ 8,307     $ 8,381  
Legal, consulting and other professional expenses
    7,377       12,621  
Stock option expense
    1,260       1,349  
Pharmacovigilance
    2,474       1,991  
Other expenses
    5,995       5,815  
Total
  $ 25,413     $ 30,157  
 
General and administrative expenses were $25.4 million in 2013 compared to $30.2 million in 2012, a decrease of $4.7 million, or 15.7%. The decrease in general and administrative expenses was primarily due to lower legal, consulting and other professional expenses as a result of the conclusion of certain legal matters in 2012, as well as expense reductions from 2013 productivity initiatives. These decreases were partially offset by an increase in pharmacovigilance (also known as drug safety) associated with the launch of AMITIZA in Japan.
 
 
Selling and Marketing Expenses

The following summarizes our selling and marketing expenses for years ended December 31, 2013 and 2012:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2013
   
2012
 
Salaries, benefits and related costs
  $ 6,735     $ 7,232  
Consulting and other professional expenses
    4,599       4,220  
Stock option expense
    191       349  
Sample expenses
    2,556       -  
Other expenses
    6,978       6,890  
Total
  $ 21,059     $ 18,691  

 
48

 
Selling and marketing expenses were $21.1 million in 2013 compared to $18.7 million in 2012, an increase of $2.4 million, or 12.7%. The increase in selling and marketing expenses is primarily due to $1.1 million for dispensing samples of RESCULA and a further non-cash write-off of anticipated excess samples of $1.5 million.
 
Non-Operating Income and Expense

The following table summarizes our non-operating income and expense for the years ended December 31, 2013 and 2012:
 
   
Year Ended
 
   
December 31,
 
(In thousands)
 
2013
   
2012
 
Interest income
  $ 124     $ 179  
Interest expense
    (1,894 )     (2,346 )
Other income (expense), net
    2,921       1,602  
Total
  $ 1,151     $ (565 )
 
Interest income was $124,000 in 2013 compared to $179,000 in 2012, a decrease of $55,000, or 30.7%. The decrease was primarily due to lower prevailing interest rates earned by our investments and lower cash balances.

Interest expense was $1.9 million in 2013 compared to $2.3 million in 2012, a decrease of $452,000, or 19.3%. The decrease was primarily due to lower debt balance.

Other income was $2.9 million in 2013 compared to $1.6 million in 2012, an increase of $1.3 million, or 82.3%. The increase in other income was primarily due to foreign exchange gains in the current period that are unrealized non-cash and that relate to amounts held within our Japan subsidiary.

Income Taxes

For the years ended December 31, 2013 and 2012, our consolidated effective income tax rate was 38.0% and 37.6%, respectively. For the years ended December 31, 2013 and 2012, we recorded a tax expense of $3.9 and $2.9 million, respectively. The tax expense for the year ended December 31, 2012 includes a benefit of approximately $1.9 million related to the reassessment of the partial internal transfer of intellectual property. The effective tax rate in 2013 is consistent with that of 2012 due to offsetting changes in the rate, attributable primarily to the change in the effective foreign and state tax rate, impact of the intellectual property transfer, the mix of earnings by jurisdiction and the continuation of foreign losses that are not benefited due to full valuation allowances. As of December 31, 2013, the remaining valuation allowance against our deferred tax assets was $1.8 million and related to foreign jurisdictions where it is not more likely than not that these deferred tax assets would be realized.

Comparison of years ended December 31, 2012 and December 31, 2011

Revenues

The following table summarizes our revenues for the years ended December 31, 2012 and 2011:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2012
   
2011
 
Research and development revenue
  $ 21,545     $ 9,249  
Product royalty revenue
    50,696       41,517  
Product sales revenue
    5,037       -  
Co-promotion revenue
    3,576       3,378  
Contract and collaboration revenue
    633       617  
Total
  $ 81,487     $ 54,761  
 
Total revenues were $81.5 million in 2012 compared to $54.8 million in 2011, an increase of $26.7 million, or 48.8%.

Research and development revenue

Research and development revenue was $21.5 million in 2012 compared to $9.2 million in 2011, an increase of $12.3 million or 132.9%. The increase was primarily due to the receipt of the $15.0 million milestone from Abbott upon the first commercial sale of AMITIZA at dosage strength of 24 micrograms in Japanese adults.

 
49

 
 
Product royalty revenue

Product royalty revenue represents royalty revenue earned on net sales of AMITIZA in the United States, as reported to us by our partner, Takeda. In 2012, we recognized $50.7 million of product royalty revenue compared to $41.5 million in 2011, an increase of $9.2 million or 22.1%. The increase was primarily due to higher price and volume of AMITIZA net sales.

Co-promotion revenue

Co-promotion revenue represents reimbursements by Takeda of co-promotion costs for our specialty sales force. In 2012, we recognized $3.6 million of co-promotion revenue compared to $3.4 million in 2011, an increase of $198,000 or 5.9%, as a result of a change in the method of reimbursement following the ending of the applicable provision in the Supplemental Takeda Agreement.

 
Product sales revenue

Product sales revenue represents sales of AMITIZA in Europe and Japan.  Product sales revenue was $5.0 million and nil in 2012 and 2011, respectively.  This increase was due to the commencement of product sales of AMITIZA in Japan in the fourth quarter of 2012.
 
 
Cost of Goods Sold

Cost of goods sold relates to purchase and distribution costs of AMITIZA in Europe and Japan. Cost of goods sold was $3.0 million and nil in 2012 and 2011, respectively, an increase of $3.0 million, or 100%. This increase was due to the commencement of product sales of AMITIZA in Japan in the fourth quarter of 2012.
 
 
Research and Development Expenses

The following summarizes our research and development expenses for the years ended December 31, 2012 and 2011:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2012
   
2011
 
Direct costs:
           
Lubiprostone
  $ 8,311     $ 23,998  
Cobiprostone
    2,019       520  
Ion channel activator
    581       611  
Unoprostone isopropyl
    2,819       2,961  
Other
    5,179       3,694  
Total
    18,909       31,784  
                 
Indirect costs
    2,383       1,713  
Total
  $ 21,292     $ 33,497  
 
Total research and development expenses in 2012 were $21.3 million compared to $33.5 million in 2011, a decrease of $12.2 million, or 36.4%. The decrease was primarily due to higher expenses in 2011 associated with the completion of the phase 3 OIC trial for AMITIZA.

General and Administrative Expenses

The following summarizes our general and administrative expenses for years ended December 31, 2012 and 2011:

 
50

 
   
Year Ended
 
   
December 31,
 
(In thousands)
 
2012
   
2011
 
Salaries, benefits and related costs
  $ 8,381     $ 6,670  
Legal, consulting and other professional expenses
    12,621       27,225  
Stock option expense
    1,349       964  
Pharmacovigilance
    1,991       209  
Other expenses
    5,815       6,202  
Total
  $ 30,157     $ 41,270  
 
General and administrative expenses were $30.2 million in 2012 compared to $41.3 million in 2011, a decrease of $11.1 million, or 26.9%. The decrease in legal, consulting and other professional expenses relates primarily to lower costs incurred following the conclusion of certain legal matters, including our concluded disputes with Takeda and a CRO. The increase in other expenses primarily relates to higher costs incurred in connection with corporate marketing and branding and staff organizations to support business growth.

Selling and Marketing Expenses

The following summarizes our selling and marketing expenses for years ended December 31, 2012 and 2011:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2012
   
2011
 
Salaries, benefits and related costs
  $ 7,232     $ 5,701  
Consulting and other professional expenses
    4,220       9  
Stock option expense
    349       172  
Other expenses
    6,890       2,901  
Total
  $ 18,691     $ 8,783  
 
Selling and marketing expenses were $18.7 million in 2012 compared to $8.8 million in 2011, an increase of $9.9 million, or 112.8%. The increase in consulting and other professional expenses and other expenses relates primarily to some non-recurring pre-commercialization planning activities for AMITIZA, and commercialization and launch costs for RESCULA. Part of the ongoing AMITIZA co-promotion expenses are funded by Takeda and recorded as co-promotion revenue.

Non-Operating Income and Expense

The following table summarizes our non-operating income and expense for the years ended December 31, 2012 and 2011:

   
Year Ended
 
   
December 31,
 
(In thousands)
 
2012
   
2011
 
Interest income
  $ 179     $ 249  
Interest expense
    (2,346 )     (2,455 )
Other expense, net
    1,602       (2,019 )
Total
  $ (565 )   $ (4,225 )
 
Interest income was $179,000 in 2012 compared to $249,000 in 2011, a decrease of $70,000, or 28.1%. The decrease was primarily due to lower prevailing interest rates earned by our investments and lower cash balances.

Interest expense was $2.3 million in 2012 compared to $2.5 million in 2011, a decrease of $109,000, or 4.4%. The decrease was primarily due to lower debt balance.

Other income was $1.6 million in 2012 compared to other expense of $2.0 million in 2011, an increase of $3.6 million. The majority of the increase relates to foreign exchange losses in the prior year that are unrealized, non-cash and that relate to amounts held within subsidiaries.

Income Taxes

For the years ended December 31, 2012 and 2011, our consolidated effective income tax rate was 37.6% and 21.0%, respectively. For the years ended December 31, 2012 and 2011, we recorded a tax expense of $2.9 million and a tax benefit of $4.6 million, respectively. The tax expense for the year ended December 31, 2012 includes a benefit of approximately $1.9 million related to the reassessment of the partial internal transfer of intellectual property. The change in our effective tax rate in 2012 from 2011 was attributable primarily to the change in the effective state tax rate, impact of the intellectual property transfer, the mix of earnings by jurisdiction and the continuation of foreign losses that are not benefited due to full valuation allowances. As of December 31, 2012, the remaining valuation allowance against our deferred tax assets was $4.1 million and related to foreign jurisdictions where it is not more likely than not that these deferred tax assets would be realized.

 
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Reportable Geographic Segments

We have determined that we have three reportable segments based on our method of internal reporting, which disaggregates the business by geographic location. These segments are the Americas, Europe and Asia. We evaluate the performance of these segments based primarily on income (loss) from operations, as well as other factors that depend on the growth of these geographies. Such measures include the progress of research and development activities, collaboration and licensing efforts, commercialization activities and other factors. The financial results of our segments reflect their varying stages of development.

Our Americas segment activities include the commercialization of RESCULA, AMITIZA income and costs associated with the Takeda collaboration.  The segment recorded an income before taxes of $21.0 million in 2013, compared to $11.5 million in 2012, an increase of $9.5 million, or 83.0%.  This increase is primarily attributable to the receipt of the $10.0 million milestone payment from Takeda in 2013 upon the first commercial sale of AMITIZA for OIC. The 2012 income before taxes of $11.5 million represents an increase of $17.8 million, or 279.6%, over the 2011 loss before taxes of $6.4 million. These results primarily reflect lower expenses associated with research and development and legal expenses, as well as an increase in royalty revenues.

Our Europe segment activities include the commercialization of AMITIZA in Europe, costs associated with pipeline development, intellectual property management and licensing activities.  The segment recorded a loss before taxes of $12.4 million in 2013, compared to a loss before taxes of $15.9 million in 2012, a decrease of $3.4 million, or 21.7%. The 2012 loss before taxes of $15.9 million represents an increase of $5.8 million, or 57.3%, over the 2011 loss before taxes of $10.1 million.

Our Asia segment activities include the commercialization of AMITIZA in Japan as a result of our collaboration with Abbott.  The segment recorded an income before taxes of $1.8 million in 2013, compared to $12.2 million in 2012, a decrease of $10.4 million, or 85.2%. This decrease is primarily attributable to the milestone payment received from Abbott in 2012. The 2012 income before taxes of $12.2 million represents an increase of $17.6 million, or 323.2%, over the 2011 loss before taxes of $5.4 million. These results primarily reflect revenue recognized during 2012 from the milestone payment received from Abbott.
 
(In thousands)
 
Americas
   
Europe
   
Asia
   
Consolidated
 
Year Ended December 31, 2013
                       
Total revenues
  $ 73,637     $ 108     $ 15,849     $ 89,594  
Income (loss) before taxes
    20,983       (12,425 )     1,789       10,347  
Identifiable assets
    95,350       23,843       17,780       136,973  
                                 
Year Ended December 31, 2012
                               
Total revenues
  $ 61,026     $ 30     $ 20,431     $ 81,487  
Income (loss) before taxes
    11,463       (15,861 )     12,150       7,752  
Identifiable assets
    87,731       25,465       14,600       127,796  
                                 
Year Ended December 31, 2011
                               
Total revenues
  $ 53,493     $ -     $ 1,268     $