**Sucampo Pharmaceuticals, Inc.****Form 10-Q Index**           **Page**   **Part I.  FINANCIAL INFORMATION**    Item 1. Condensed Consolidated Financial Statements (unaudited)  1   Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007  1   Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income for the Three and Nine Months Ended September 30, 2008 and 2007  2   Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2008  3   Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007  4   Notes to Condensed Consolidated Financial Statements  5 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  17 Item 3. Quantitative and Qualitative Disclosures About Market Risk  27 Item 4. Controls and Procedures  27   **Part II.  OTHER INFORMATION**    Item 1. Legal Proceedings  27 Item 1A. Risk Factors  27 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  29 Item 4. Submission of Matters to a Vote of Security Holders  29 Item 6. Exhibits  30 **SIGNATURES**    31 **INDEX TO EXHIBITS**  32 
 

 
**PART I — FINANCIAL INFORMATION****Item 1.*****Condensed Consolidated Financial Statements (Unaudited)*****SUCAMPO PHARMACEUTICALS, INC.****Condensed Consolidated Balance Sheets (Unaudited)**(In thousands, except share data)           **September 30,**  **December 31,**   **2008**  **2007** **ASSETS:**                 Current assets:        Cash and cash equivalents $13,364  $25,559 Investments, current  93,117   51,552 Product royalties receivable  7,611   8,667 Unbilled accounts receivable  4,664   5,883 Accounts receivable  1,076   1,525 Prepaid and income taxes receivable  119   1,922 Deferred tax assets, net  1,066   88 Prepaid expenses and other current assets  2,226   2,222        Total current assets  123,243   97,418          Investments, non-current  17,626   9,400 Property and equipment, net  2,283   2,265 Deferred tax assets — noncurrent, net  4,566   551 Other assets  401   393        Total assets $148,119  $110,027                 **LIABILITIES AND STOCKHOLDERS’ EQUITY:**                 Current liabilities:        Accounts payable $2,959  $3,313 Accrued expenses  12,491   8,730 Deferred revenue — current  6,379   1,062 Income taxes payable  1,420   —        Total current liabilities  23,249   13,105          Deferred revenue, net of current portion  8,202   8,626 Other liabilities  1,615   1,768        Total liabilities  33,066   23,499                 Commitments (Note 7)                 Stockholders’ equity:        Preferred stock, $0.01 par value; 5,000,000shares authorized at September 30, 2008 andDecember 31, 2007; no shares issued andoutstanding at September 30, 2008 andDecember 31, 2007  —   — Class A common stock, $0.01 par value;270,000,000 shares authorized at September30, 2008 and December 31, 2007; 15,650,398and 15,538,518 shares issued andoutstanding at September 30, 2008 andDecember 31, 2007, respectively  156   155 Class B common stock, $0.01 par value;75,000,000 shares authorized at September30, 2008 and December 31, 2007; 26,191,050shares issued and outstanding at September30, 2008 andDecember 31, 2007  262   262 Additional paid-in capital  98,272   96,680 Accumulated other comprehensive loss  (1,416)  (393)Retained earnings (accumulated deficit)  17,779   (10,176)       Total stockholders’ equity  115,053   86,528        Total liabilities and stockholders’ equity $148,119  $110,027        The accompanying notes are an integral part of these condensed consolidated financialstatements.
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**SUCAMPO PHARMACEUTICALS, INC.****Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income (Unaudited)**(In thousands, except per share data)                   **Three Months Ended September 30,**  **Nine Months Ended September 30,**   **2008**  **2007**  **2008**  **2007** Revenues:                Research and development revenue $5,436  $4,652  $66,982  $52,105 Product royalty revenue  7,718   6,998   24,699   18,869 Co-promotion revenue  1,185   1,051   3,643   3,318 Contract and collaboration revenue  142   151   425   454              Total revenues  14,481   12,852   95,749   74,746                               Operating expenses:                Research and development  11,390   7,588   35,537   22,278 General and administrative  3,863   2,116   10,591   17,286 Selling and marketing  2,680   2,779   8,398   9,806 Milestone royalties — related parties  —   —   3,531   1,500 Product royalties — related parties  1,359   1,244   4,391   3,354              Total operating expenses  19,292   13,727   62,448   54,224                               (Loss) income from operations  (4,811)  (875)  33,301   20,522 Non-operating income (expense):                Interest income  655   780   1,862   1,575 Other expense, net  (15)  (228)  (16)  (192)             Total non-operating income, net  640   552   1,846   1,383                               (Loss) income before income taxes  (4,171)  (323)  35,147   21,905 Income tax benefit (provision)  1,745   (151)  (7,192)  (7,980)             Net (loss) income $(2,426) $(474) $27,955  $13,925                               Net (loss) income per share:                Basic net (loss) income per share $(0.06) $(0.01) $0.67  $0.38              Diluted net (loss) income per share $(0.06) $(0.01) $0.67  $0.38              Weighted average common shares outstanding — basic  41,813   39,312   41,768   36,447              Weighted average common shares outstanding — diluted  41,813   39,312   42,022   36,835                               Comprehensive income:                Net (loss) income $(2,426) $(474) $27,955  $13,925 Other comprehensive (loss) income:                Unrealized gain (loss) on investments, net of tax effect  374   —   (1,082)  — Foreign currency translation  54   281   59   205              Comprehensive (loss) income $(1,998) $(193) $26,932  $14,130              The accompanying notes are an integral part of these condensed consolidated financial statements.
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**SUCAMPO PHARMACEUTICALS, INC.****Condensed Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)**(In thousands, except share data)                                                       **Accumulated**  **Retained**      **Class A**  **Class B**  **Additional**  **Other**  **Earnings**  **Total**   **Common Stock**  **Common Stock**  **Paid-In**  **Comprehensive**  **(Accumulated**  **Stockholders’**   **Shares**  **Amount**  **Shares**  **Amount**  **Capital**  **Loss**  **Deficit)**  **Equity** Balance at December 31, 2007  15,538,518  $155   26,191,050  $262  $96,680  $(393) $(10,176) $86,528 Stock issued upon exercise of stock options  111,880   1   —   —   869   —   —   870 Employee stock option expense, net of tax benefit  —   —   —   —   723   —   —   723 Foreign currency translation  —   —   —   —   —   59   —   59 Unrealized loss on investments, net of tax effect  —   —   —   —   —   (1,082)  —   (1,082)Net income  —   —   —   —   —   —   27,955   27,955                          Balance at September 30, 2008  15,650,398  $156   26,191,050  $262  $98,272  $(1,416) $17,779  $115,053                          The accompanying notes are an integral part of these condensed consolidated financial statements.
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**SUCAMPO PHARMACEUTICALS, INC.****Condensed Consolidated Statements of Cash Flows (Unaudited)**(In thousands)           **Nine Months Ended September 30,**   **2008**  **2007** Cash flows from operating activities:        Net income $27,955  $13,925 Adjustments to reconcile net income to net cash provided by operating activities:        Depreciation and amortization  326   153 Loss on disposal of property and equipment  —   63 Deferred tax (benefit) provision  (4,312)  4,413 Stock-based compensation  567   6,144 Accretion of discounts on investments  (95)  — Changes in operating assets and liabilities:        Accounts receivable  493   (2,831)Unbilled accounts receivable  1,219   — Product royalties receivable  1,055   (4,969)Prepaid and income taxes receivable and payable, net  3,224   (759)Accounts payable  (415)  1,951 Accrued expenses  3,815   1,145 Deferred revenue  4,893   (11,376)Other assets and liabilities, net  (114)  549        Net cash provided by operating activities  38,611   8,408                 Cash flows from investing activities:        Purchases of investments  (135,584)  (86,847)Proceeds from sales of investments  41,000   55,795 Maturities of investments  43,125   — Purchases of property and equipment  (342)  (2,128)       Net cash used in investing activities  (51,801)  (33,180)                Cash flows from financing activities:        Proceeds from exercise of stock options  870   — Excess tax benefits from share-based payments  155   — Issuance of common stock, net of offering costs  —   31,341        Net cash provided by financing activities  1,025   31,341                 Effect of exchange rates on cash and cash equivalents  (30)  186                 Net (decrease) increase in cash and cash equivalents  (12,195)  6,755 Cash and cash equivalents at beginning of period  25,559   22,481        Cash and cash equivalents at end of period $13,364  $29,236        The accompanying notes are an integral part of these condensed consolidated financial statements.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited)****1. Business Organization and Basis of Presentation*****Description of the Business***     Sucampo Pharmaceuticals, Inc. (Sucampo or the Company) is a biopharmaceutical company focusedon the discovery, development and commercialization of proprietary drugs based on prostones, aclass of compounds derived from functional fatty acids that occur naturally in the human body.Sucampo is focused on developing prostones for the treatment of gastrointestinal, respiratory,vascular and central nervous system diseases and disorders.     The Company is party to a collaboration and license agreement with Takeda PharmaceuticalCompany Limited (Takeda) to jointly develop and commercialize AMITIZA® (lubiprostone)for chronic idiopathic constipation, irritable bowel syndrome with constipation, opioid-inducedbowel dysfunction and other gastrointestinal indications in the United States and Canada. InJanuary 2006, the Company received marketing approval from the U.S. Food and Drug Administration(FDA) for AMITIZA’s first indication to treat chronic idiopathic constipation in adults.Commercialization of AMITIZA began in April 2006 throughout the United States. On April 29, 2008,the Company received marketing approval from the FDA for AMITIZA to treat irritable bowel syndromewith constipation in women 18 years of age or older. Commercialization for this indication began inMay 2008 throughout the United States. The Company is currently conducting Phase III pivotalclinical trials of AMITIZA for the treatment of opioid-induced bowel dysfunction.     The Company’s founders own directly or indirectly the majority holdings in Sucampo as well asin other companies that have contractual relationships with Sucampo. One of the Company’s foundersserves as the Chairman of the Board of Directors, Chief Executive Officer and Chief ScientificOfficer of the Company.     The Company’s international operations are conducted through its subsidiaries in the UnitedKingdom and Japan.***Basis of Presentation***     The accompanying unaudited condensed consolidated financial statements of the Company havebeen prepared in accordance with accounting principles generally accepted in the United States ofAmerica (GAAP) and the rules and regulations of the Securities and Exchange Commission (SEC) forinterim financial information. Accordingly, they do not include all of the information andfootnotes required by GAAP for complete financial statements and should be read in conjunction withthe Company’s consolidated financial statements as of and for the year ended December 31, 2007,included in the Company’s Annual Report on Form 10-K. The financial information as of September 30,2008 and for the three and nine months ended September 30, 2008 and 2007 is unaudited. In theopinion of management, all adjustments, consisting only of normal recurring adjustments oraccruals, considered necessary for a fair statement of the results of these interim periods havebeen included. The results of the Company’s operations for any interim period are not necessarilyindicative of the results that may be expected for any other interim period or for a full fiscalyear.     The condensed consolidated financial statements include the accounts of Sucampo and itswholly-owned subsidiaries. All significant inter-company balances and transactions have beeneliminated in the consolidated accounts.**2. Summary of Significant Accounting Policies*****Current and Non-Current Investments***     Current and non-current investments consist primarily of U.S. Treasury bills and notes andauction rate securities. The Company’s investments in these securities are classified asavailable-for-sale securities under Statement of Financial Accounting Standards (SFAS) No. 115,*“Accounting for Certain Investments in Debt and Equity Securities”*(SFAS 115).     Theavailable-for-sale securities are accounted for at fair market value and unrealized gains andlosses on these securities, if any, are included in accumulated other comprehensive loss instockholders’ equity. The fair value of the securities is measured in accordance with SFAS No. 157,*“Fair Value Measurements”*(SFAS 157), which was adopted by the Company on January 1, 2008.SFAS 157 addresses how companies should measure fair value when they are required to use a fairvalue measure for recognition and disclosure purposes under generally accepted accountingprinciples. The Company assesses the recoverability of its available-for-sale securities and, ifimpairment is indicated, the Company measures the amount of such impairment by comparing the fairvalue to the carrying value. Other-than-temporary impairments are included in the condensedconsolidated statement of operations and comprehensive (loss) income. Any future fluctuation infair value related to these instruments that the Company deems to be temporary, including anyrecoveries of previous write-downs, will be recorded to other comprehensive income.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)**     The adoption of SFAS 157 did not materially affect the Company’s financial condition, itsresults of operations, or its cash flows. SFAS 157 establishes a three-tier fair value hierarchy,which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined asobservable inputs such as quoted prices in active markets; Level 2, defined as inputs other thanquoted prices in active markets that are either directly or indirectly observable; and Level 3,defined as unobservable inputs in which little or no market data exists, therefore requiring anentity to develop its own assumptions. See additional disclosures related to the determination ofthe fair value of the Company’s investments (see Note 4).     The Company also adopted SFAS No. 159, *“The Fair Value Option for Financial Assets andFinancial Liabilities, Including an Amendment of FASB Statement No. 115”*(SFAS 159), which permitsentities to measure many financial instruments and certain other assets and liabilities at fairvalue on an instrument-by-instrument basis, on January 1, 2008. The adoption of SFAS 159 did notmaterially affect the Company’s financial condition, results of operations, or cash flows as theCompany has not elected to account for any assets or liabilities at fair value on aninstrument-by-instrument basis.***Certain Risks, Concentrations and Uncertainties***     Financial instruments that potentially subject the Company to significant concentrations ofcredit risk consist of cash and cash equivalents, restricted cash, investments and receivables. TheCompany places its cash and cash equivalents, restricted cash and investments with highly ratedfinancial institutions. At September 30, 2008 and December 31, 2007, the Company had approximately$98.1 million and $85.9 million, respectively, of cash and cash equivalents, restricted cash andinvestments in excess of government insured limits. The Company’s uninsured cash, cash equivalentsand investments as of September 30, 2008 consist primarily of $70.8 million of T-bills and notesand $18.9 million of money market funds guaranteed under the U.S. Treasury’s Temporary GuaranteeProgram. The Company has not experienced any losses on these accounts related to amounts in excessof insured limits.     At September 30, 2008, the Company holds $21.0 million of investments in auction ratesecurities at fair value and has recorded a cumulative unrealized loss of $1.9 million, or $1.2million net of tax effect, as of September 30, 2008 related to these investments. This unrealizedloss was recorded as other comprehensive loss during the nine months ended September 30, 2008.     On October 16, 2008, the Company accepted the settlement rights offered by the Company’sbroker under a settlement agreement between the broker and the SEC and various state regulatoryauthorities. The settlement rights allow the Company to redeem auction rate securities at parwithin a specified period. Based on this settlement, the Company received $3.4 million on November3, 2008, representing the par value of its tax-exempt auction rate securities and has the right torequest the redemption of the remaining auction rate securities at par value of an additional $19.4million within, the two-year period starting June 30, 2010. As the settlement was acceptedsubsequent to September 30, 2008, the Company’s consolidated financial statements as of September30, 2008 do not reflect any contingent gains, valuation adjustments or any other amounts relatingto the settlement rights. The Company has, however, classified auction rate securities as currentand non-current investments as of September 30, 2008 based on the expected redemption dates. TheCompany does not anticipate having to sell these securities in order to operate its business beforethe expected redemption dates.     The Company’s product, AMITIZA, and other candidates under development require approval fromthe FDA or other international regulatory agencies prior to commercial sales. For those productcandidates that have not yet been approved by the FDA, or international regulatory agencies, therecan be no assurance the products will receive the necessary approval. If the Company is deniedapproval or approval is delayed, it may have a material adverse impact on the Company.     The Company’s product, AMITIZA, competes in a rapidly changing, highly competitive market,which is characterized by advances in scientific discovery, changes in customer requirements,evolving regulatory requirements and developing industry standards. Any failure by the Company toanticipate or to respond adequately to scientific developments in its industry, changes in customerrequirements or changes in regulatory requirements or industry standards, or any significant delaysin the development or introduction of products or services could have a material adverse effect onthe Company’s business, operating results and future cash flows.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)**     The Company’s expected activities may necessitate significant uses of working capital. TheCompany’s working capital requirements will depend on many factors, including the successful salesof AMITIZA, research and development efforts to develop new products, payments received undercontractual agreements with other parties, the status of competitive products and market acceptanceof the Company’s new products by physicians and patients. The Company plans to continue financingoperations with product royalty revenue as well as with cash received from milestones and otherrevenue related to its joint collaboration and license agreement and the supplemental agreemententered into with Takeda (see Note 9).     The Company depends significantly upon the collaboration with Takeda and the Company’sactivities may be affected if this relationship is disrupted. Revenues from Takeda accounted formore than 99% of the Company’s total revenues for the three months ended September 30, 2008 and2007 and the nine months ended September 30, 2008 and 2007. Accounts receivable, unbilled accountsreceivable and product royalties receivable from Takeda accounted for 98% and 99% of the Company’saccounts receivable, unbilled accounts receivable and product royalties receivable at September 30,2008 and December 31, 2007, respectively (see Note 9).     The Company has an exclusive supply arrangement with R-Tech Ueno, Ltd (R-Tech), an affiliate,to provide it with commercial and clinical supplies of its product and product candidates. R-Techalso provides certain preclinical and other research and development services. Any difficulties ordelays in performing the services under these arrangements may cause the Company to lose revenues,delay research and development activities or otherwise disrupt the Company’s operations (see Note8).     The Company has previously entered into a restated license agreement with Sucampo AG (SAG) togrant the Company a royalty-bearing, exclusive, worldwide license to develop prostone compounds,including AMITIZA and cobiprostone. SAG is a Swiss-patent holding company and an affiliate. TheCompany’s success depends, in part, on SAG’s ability to obtain and maintain proprietary protectionfor the intellectual property rights relating to the prostone technology and products (see Note 8).***Deferred Revenue***     Deferred revenue represents payments received or receivables for licensing fees, option fees,consulting, research and development contracts and related cost sharing and supply agreements thatare deferred until revenue can be recognized under the Company’s revenue recognition policy.Deferred revenue is classified as current if management believes the Company will be able torecognize the deferred amount as revenue within 12 months of the balance sheet date. During thesecond quarter of 2008, the Company agreed to receive quarterly prepayments from Takeda for itsresearch and development expenses under the agreements with Takeda. As of September 30, 2008,approximately $1.9 million of deferred revenue relates to these prepayments (see Note 6).***Reclassifications***     Certain amounts in the previously issued financial statements have been reclassified toconform with the current presentation. The Company reclassified expenses that have been previouslyincluded within general and administrative expenses to research and development expenses. Suchexpenses primarily include salaries and other employee benefits of personnel who oversee theresearch and development process, and allocated depreciation and rent expenses and insurance costs.The Company also reclassified allocated depreciation and rent expenses and insurance costs fromgeneral and administrative expenses to selling and marketing expenses.During the three months ended September 30, 2007, the Company reclassified $828,000 and$84,000 of general and administrative expenses to research and development expenses and selling andmarketing expenses, respectively. During the nine months ended September 30, 2007, the Companyreclassified approximately $2.2 million and $154,000 of general and administrative expenses toresearch and development expenses and selling and marketing expenses, respectively.***Cumulative Out-of-Period Adjustment***     The Company recorded a cumulative adjustment of approximately $148,000 during the nine monthsended September 30, 2008 to recognize additional research and development expenses that have notbeen recorded in prior periods. The error resulted from incorrect accounting for investigatorservices for the Phase IIb study of lubiprostone for adult chronic idiopathic constipationinitiated in Japan in the fourth quarter of 2007. The effect of this adjustment on the consolidatedfinancial statements was not material for the year ended December 31, 2007 or for the period inwhich it was recorded, as the adjustment consisted of insignificant amounts related to each ofthese periods.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)*****Changes in Estimate***     In June 2006, a joint committee comprised of representatives of the Company and Takeda (theJoint Commercialization Committee) granted approval for the Company and Takeda to begin threestudies related to funding arrangements discussed in the collaboration and license agreement andits supplement. The Company accounts for these three required deliverables as a single unit ofaccounting for revenue recognition purposes. Effective April 1, 2008, as a result oflower-than-expected patient enrollment in one of the studies, the Joint Commercialization Committeeapproved an increase in funding for patient recruitment. Additionally, the Company concluded thatthe estimated completion of these trials would be extended from June 2009 to December 2009. Assuch, the Company determined that the recognition period for associated research and developmentrevenue should be extended. The related research and development revenue is limited to the lesserof the actual cumulative reimbursable costs incurred or the cumulative straight-line amount ofrevenue recognized over the estimated performance period. As a result of the extended completiondate and an increase of total expected reimbursable costs, the Company deferred approximately $1.9million and $3.6 million in research and development revenue for the three and nine months endedSeptember 30, 2008, respectively. The Company expects to recognize the deferred revenue of $3.6million in 2009. Under the provision of SFAS No. 154, *“Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20 and FASB Statement No. 3”*(SFAS 154), the Company will recognizethis as a change in estimate on a prospective basis from April 1, 2008.     During the three months ended September 30, 2008, as additional historic information becameavailable, the Company refined its estimated rebates, discounts and other expenses deducted fromTakeda’s gross sales in order to calculate Takeda’s net sales and product royalties due from Takedato the Company. As a result of this, the Company recorded a reduction to its product royaltyrevenues of $644,000 during the three months ended September 30, 2008.     The above changes in estimate have the following impact on net income and basic and dilutednet income per share for the three and nine months ended September 30, 2008:           **Three Months Ended** **Nine Months Ended****(In thousands, except per share data)** **September 30, 2008** **September 30, 2008**Decrease in revenue and income before income taxes $(2,570) $(4,263)Impact on basic net (loss) income per share  (0.03)  (0.02)Impact on diluted net (loss) income per share  (0.03)  (0.02)***Recent Accounting Pronouncements***     In June 2007, the Emerging Issues Task Force (EITF) issued EITF Issue No. 07-3, *“Accountingfor Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research andDevelopment Activities”*(EITF 07-3), which provides guidance toresearch and development companies on how to account for the nonrefundable portion of anadvance payment made for research and development activities. The Company adopted EITF 07-3 as ofJanuary 1, 2008 and there was no material impact upon its adoption.     In December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 141 (revised 2007), *“Business Combinations”*(SFAS 141R)and SFAS No. 160, *“Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51”*(SFAS 160).SFAS 141R will change how business acquisitions are accounted for and will impact financialstatements both on the acquisition date and in subsequent periods. SFAS 160 will change theaccounting and reporting for minority interests, which will be recharacterized as noncontrollinginterests and classified as a component of equity. SFAS 141R and SFAS 160 will be applied toacquisitions that close in years beginning after December 15, 2008. Early adoption is notpermitted. SFAS 141R and SFAS 160 will not have any impact on the Company’s future consolidatedfinancial statements unless it undertakes an acquisition in the future.     In December 2007, the FASB ratified EITF Issue No. 07-1, *“Accounting for CollaborativeArrangements”*(EITF 07-1). The consensus prohibits the equity method of accounting forcollaborative arrangements under Accounting Principles Board No. 18, *“The Equity Method ofAccounting for Investments in Common Stock"*, unless a legal entity exists. Payments between thecollaborative partners will be evaluated and reported in the income statement based on applicableGAAP. Absent specific GAAP, the participants to the arrangement will apply other existing GAAP byanalogy or apply a reasonable and rational accounting policy consistently. The guidance in EITF07-1 is effective for periods that begin after December 15, 2008 and will apply to arrangements inexistence as of the effective date. The effect of the new consensus will be accounted for as achange in accounting principle through retrospective application. EITF 07-1 will not have anyimpact on the consolidated financial statements upon adoption.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)**     In February 2008, the FASB agreed to delay the effective date of SFAS 157 for all nonfinancialassets and nonfinancial liabilities, except those that are recognized or disclosed at fair value inthe financial statements on a recurring basis, to fiscal years beginning after November 15, 2008.The Company adopted SFAS 157 with respect to its financial assets and liabilities as of January 1,2008 and does not expect that the adoption of SFAS 157 for its nonfinancial assets and liabilitieswill have a significant impact on its financial position or results from operations.**3. Earnings per Share**     Basic net income (loss) per share is computed by dividing net income (loss) by the sum of theweighted average class A and B common shares outstanding. Diluted net income per share is computedby dividing net income by the weighted average common shares and potential dilutive common sharesoutstanding, except when their inclusion would be anti-dilutive.     The computation of net income per share for the three and nine months ended September 30, 2008and 2007 is shown below:                   **Three Months Ended September 30,**  **Nine Months Ended September 30,** **(In thousands, except per share data)** **2008**  **2007**  **2008**  **2007** Basic net (loss) income per share:                Net (loss) income $(2,426) $(474) $27,955  $13,925              Weighted average class A and Bcommon shares outstanding  41,813   37,252   41,768   35,753 Conversion of series A preferredstock to class A common sharesoutstanding  —   2,060   —   694                 41,813   39,312   41,768   36,447                               Basic net (loss) income per share $(0.06) $(0.01) $0.67  $0.38                               Diluted net (loss) income per share:                Net (loss) income $(2,426) $(474) $27,955  $13,925              Weighted average class A and Bcommon shares outstanding fordiluted net income per share  41,813   39,312   41,768   36,447 Assumed exercise of stock optionsunder the treasury stock method  —   —   254   388                 41,813   39,312   42,022   36,835                               Diluted net (loss) income per share $(0.06) $(0.01) $0.67  $0.38                   The potentially dilutive securities used in the calculations of diluted historical net incomeper share as of the nine months ended September 30, 2008 and 2007 are as follows:           **September 30,****(In thousands)** **2008** **2007**Employee stock options  381   641 Non-employee stock options  450   510      Potentially dilutive securities representing approximately 407,000 and nil shares of commonstock for the three months ended September 30, 2008 and 2007, respectively, were excluded from thecomputation of diluted earnings per share for the periods because their effect would have beenanti-dilutive.**4. Current and Non-Current Investments**     At September 30, 2008 and December 31, 2007, current and non-current available-for-saleinvestments consisted of the following securities:
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)**                   **September 30, 2008**       **Unrealized**  **Unrealized**    **(In thousands)** **Cost**  **Gains**  **Losses**  **Fair Value** *Current:*                U.S. Treasury bills and notes $70,716  $115  $—  $70,831 Auction rate securities  3,475   —   (104)  3,371 Money market funds  18,915   —   —   18,915              Total $93,106  $115  $(104) $93,117                               *Non-current:*                Auction rate securities $19,400  $—  $(1,774) $17,626                                 **December 31, 2007**       **Unrealized**  **Unrealized**    **(In thousands)** **Cost**  **Gains**  **Losses**  **Fair Value** *Current:*                Auction rate securities $51,500  $—  $—  $51,500 Money market funds  52   —   —   52              Total $51,552  $—  $—  $51,552                               *Non-current:*                Auction rate securities $9,400  $—  $—  $9,400                   The Company’s assets measured at fair value on a recurring basis, which are subject to thedisclosure requirements of SFAS 157, at September 30, 2008 were as follows:                   **Fair Value Measurements at Reporting Date Using**   **Quoted Prices in**      **Significant**      **Active Markets for**  **Significant Other**  **Unobservable**  **Total as of**   **Identical Assets**  **Observable Inputs**  **Inputs**  **September 30,** **(In thousands)** **(Level 1)**  **(Level 2)**  **(Level 3)**  **2008** U.S. Treasury bills and notes $70,831  $—  $—  $70,831 Auction rate securities  —   —   20,997   20,997 Other available-for-sale securities  18,915   —   —   18,915              Total assets measured at fair value $89,746  $—  $20,997  $110,743                   Based on market conditions, the Company changed its valuation methodology for auction ratesecurities to a valuation method that includes market and income approaches during the firstquarter of 2008. Accordingly, these securities changed from Level 1 to Level 3 within SFAS 157’svaluation hierarchy at the time of the Company’s initial adoption of SFAS 157 at January 1, 2008.The Level 2 securities consist of the auction rate securities that were redeemed at par during2008. The following table presents the Company’s assets measured at fair value on a recurring basisusing significant observable inputs (Level 2) and significant unobservable inputs (Level 3) asdefined in SFAS 157 during the nine months ended September 30, 2008:       **Auction Rate** **(In thousands)** **Securities** Balance at January 1, 2008 $9,400 Transfers to Level 2  (3,900)Transfers to Level 3  51,500 Total gains (losses) (realized or unrealized):    Included in earnings  — Included in other comprehensive loss  (1,878)Purchases  5,100 Settlements  (39,225)    Balance at September 30, 2008 $20,997     
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)****5. Accrued Expenses**     Accrued expenses consist of the following:           **September 30,**  **December 31,** **(In thousands)** **2008**  **2007** Research and development costs $7,717  $4,422 Selling and marketing costs  352   384 Employee compensation  1,589   1,867 Legal service fees  268   226 Product royalty liability — related party  1,706   1,536 Other accrued expenses  859   295          $12,491  $8,730        **6. Deferred Revenue**     Total deferred revenue consists of the following:           **September 30,**  **December 31,** **(In thousands)** **2008**  **2007** Deferred revenue — current $6,379  $1,062 Deferred revenue, net of current portion  8,202   8,626          $14,581  $9,688             During the second quarter of 2008, the Company agreed to receive quarterly prepayments fromTakeda for its research and development expenses under the agreements with Takeda. As of September30, 2008, approximately $1.9 million of deferred revenue relates to these prepayments. As a resultof the change in estimate (see Note 2) resulting from an extended completion date and an increaseof total expected reimbursable costs of certain clinical studies, the Company deferredapproximately $3.6 million in research and development revenue as of September 30, 2008.**7. Commitments*****Operating Leases***     The Company leases office space in the United States, United Kingdom and Japan under operatingleases through 2017. Total future minimum, non-cancelable lease payments under operating leases,which do not include future sublease receipts of $299,000, are as follows as of September 30, 2008:     **(In thousands)**    2008 $402 2009  1,520 2010  1,049 2011  938 2012  963 2013 and thereafter  4,243     Total minimum lease payments $9,115          Rent expense for all operating leases was $296,000 and $288,000 for the three months endedSeptember 30, 2008 and 2007, respectively, and $874,000 and $751,000 for the nine months endedSeptember 30, 2008 and 2007, respectively.***Research and Development Costs***     The Company routinely enters into agreements with clinical research organizations (CROs), tooversee clinical research and development studies provided on an outsourced basis and assist inother research and development activities. The Company generally is not contractually obligated topay the third party if the service or reports are not provided. Total future estimated costs underthese agreements as of September 30, 2008 were approximately $14.3 million.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)****8. Related Party Transactions*****R-Tech Ueno, Ltd.***     The Company is a party to multiple exclusive clinical and commercial supply agreements withR-Tech, whereby R-Tech manufactures and supplies AMITIZA and other prostone compounds for Sucampo.Also, R-Tech sells commercial supplies of AMITIZA directly to Takeda, which are not recorded in thebooks of Sucampo.     The following table summarizes the Company’s transactions with R-Tech towards these services:                   **Three Months Ended September 30,**  **Nine Months Ended September 30,**   **2008**  **2007**  **2008**  **2007** **(In thousands)**                Clinical supplies $38  $1,357  $553  $2,899 Other research and development services  62   67   111   85                $100  $1,424  $664  $2,984                   The following table summarizes the amounts included in deferred revenue resulting from thedeferral of upfront payments relating to the exclusive supply agreements with R-Tech:           **September 30,**  **December 31,**   **2008**  **2007** **(In thousands)**        Deferred revenue — current $419  $419 Deferred revenue, net of current portion  6,549   6,862          $6,968  $7,281             The Company recognized approximately $105,000 of previously deferred revenue relating to itsagreements with R-Tech for the three months ended September 30, 2008 and 2007 and approximately$314,000 for the nine months ended September 30, 2008 and 2007, which was recorded as contract andcollaboration revenue in the condensed consolidated statements of operations and comprehensive(loss) income.***Sucampo AG License Agreements***     During the three months ended March 31, 2008, the Company submitted a Marketing AuthorizationApplication (MAA) for lubiprostone, 24 micrograms, for the indication of chronic idiopathicconstipation in adults in nine European countries using the decentralized procedure. The submissionof the MAA triggered the obligation on the part of the Company under the license agreement with SAGto make a $1.0 million payment to SAG. The Company recorded the expense as milestone royalties —related parties in the first quarter of 2008 and paid the milestone in the fourth quarter of 2008.     The Company expensed approximately $1.4 million and $1.2 million in product royalties —related parties under the license agreement with SAG for the three months ended September 30, 2008and 2007, respectively, and approximately $4.4 million and $3.4 million for the nine months endedSeptember 30, 2008 and 2007, respectively, based on current AMITIZA sales.**9. Collaboration and License Agreements with Takeda**     On October 29, 2004, the Company entered into a 16-year collaboration and license agreementwith Takeda to exclusively co-develop, commercialize and sell products that contain lubiprostonefor gastroenterology indications in the United States and Canada. On February 1, 2006, the Companyentered into a supplemental agreement with Takeda, which amended the responsibilities of both theCompany and Takeda for the co-promotion of AMITIZA and clarified the responsibilities and fundingarrangements for other marketing services to be performed by both parties. Payments to the Companyunder these agreements include a non-refundable up-front payment, non-refundable development andcommercial milestone payments, reimbursement of certain development and co-promotion costs andproduct royalties.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)**     The Company has received a total of $150.0 million in up-front and development milestonepayments through September 30, 2008 under these agreements. In June 2007, the Company submitted thesupplemental new drug application (sNDA) to the FDA forirritable bowel syndrome with constipation and received a $30.0 million milestone from Takedathat was recognized as revenue in the second quarter of 2007. The Company received a $50.0 millionmilestone from Takeda as a result of the FDA’s approval on April 29, 2008 of the sNDA for irritablebowel syndrome with constipation in women 18 years of age and older and recognized the payment asresearch and development revenue in the second quarter of 2008. Subject to future development andcommercial milestones, the Company is potentially entitled to receive up to $10.0 million inadditional development milestone payments and up to $50.0 millionin commercial milestone payments, under the collaboration and license agreements with Takeda,although there can be no assurance that the Company will receive any such payments.     The following table summarizes the cash streams and related collaboration and research anddevelopment revenue recognized under the collaboration and license agreements with Takeda for thenine months ended September 30, 2008:                               **Revenue**  **Change in**          **Cash Received**  **Recognized**  **Accounts**          **for the**  **for the**  **Receivable**      **Amount**  **Nine Months**  **Nine Months**  **for the Nine**  **Amount**   **Deferred at**  **Ended**  **Ended**  **Months Ended**  **Deferred at**   **December 31,**  **September 30,**  **September 30,**  **September 30,**  **September 30,** **(In thousands)** **2007**  **2008**  **2008**  **2008**  **2008** *Collaboration revenue:*                    Up-front payment associated with the Company’sobligation to participate in joint committeeswith Takeda $1,911  $—  $110  $—  $1,801                                      *Research and development revenue:*                    Development milestones $—  $50,000  $50,000  $—  $— Reimbursement of research and development expenses  —   24,653   16,982   (2,191)  5,480                 Total $—  $74,653  $66,982  $(2,191) $5,480                                      *Product royalty revenue* $—  $25,755  $24,699  $(1,056) $—                                                **Revenue**             **Cash Received**  **Recognized**             **for the**  **for the**         **Accounts**  **Nine Months**  **Nine Months**  **Accounts**  **Amount**   **Receivable at**  **Ended**  **Ended**  **Receivable at**  **Deferred at**   **December 31,**  **September 30,**  **September 30,**  **September 30,**  **September 30,** **(In thousands)** **2007***  **2008**  **2008**  **2008***  **2008** *Research and development revenue*:                    Development milestones $—  $50,000  $50,000  $—  $—                 Reimbursement of research anddevelopment expenses $6,887  $24,653  $16,982  $4,696  $5,480                                      *Product royalty revenue* $8,667  $25,755  $24,699  $7,611  $—                                      *Co-promotion revenue* $360  $3,212  $3,643  $791  $—                  * Includes billed and unbilled accounts receivable.     In connection with the Company’s MAA filing for lubiprostone in Europe, the Company agreedwith Takeda to make a one-time payment of approximately $1.8 million, which will permit the Companyto use in Europe, the Middle East and Africa certain data and information developed under theTakeda Agreement relating to the use of lubiprostone to treat chronic idiopathic constipation. TheCompany recognized this payment as a research and development expense in the first quarter of 2008.**10. Stock Option Plan**
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)**     The following table summarizes the employee stock option activity for the nine months endedSeptember 30, 2008 under the Company’s 2001 Incentive Plan:                       **Weighted**  **Weighted**  ** **       **Average**  **Average Remaining**  **Aggregate**       **Exercise Price**  **Contractual**  **Intrinsic** **(In thousands, except share and per share data)** **Shares**  **Per Share**  **Term (Years)**  **Value** Options outstanding, December 31, 2007  640,900  $10.24         Options exercised  (51,880)  10.00         Options forfeited  (34,850)  10.00         Options expired  (48,750)  10.00                         Options outstanding, September 30, 2008  505,420   10.30   6.07  $—                Options exercisable, September 30, 2008  490,545   10.31   6.02  $—                     The following table summarizes the employee stock option activity for the nine months endedSeptember 30, 2008 under the Company’s 2006 Incentive Plan:                       **Weighted**  **Weighted**  ** **       **Average**  **Average Remaining**  **Aggregate**       **Exercise Price**  **Contractual**  **Intrinsic** **(In thousands, except share and per share data)** **Shares**  **Per Share**  **Term (Years)**  **Value** Options outstanding, December 31, 2007  267,500  $14.44         Options granted  44,000   9.66         Options forfeited  (17,250)  14.12         Options expired  (11,750)  14.12                        Options outstanding, September 30, 2008  282,500   13.87   8.27  $—                Options exercisable, September 30, 2008  60,750   14.47   7.96  $—                     The weighted average grant date fair value of options granted during the nine months endedSeptember 30, 2008 and the year ended December 31, 2007 were $5.25 and $7.19, respectively. As ofSeptember 30, 2008, approximately $1.2 million of total unrecognized compensation costs, net ofestimated forfeitures, related to non-vested awards are expected to be recognized over a weightedaverage period of 2.35 years.     The following table summarizes the non-employee stock option activity for the nine monthsended September 30, 2008 under the Company’s 2001 Incentive Plan:                       **Weighted**  **Weighted**  ** **       **Average**  **Average Remaining**  **Aggregate**       **Exercise Price**  **Contractual**  **Intrinsic** **(In thousands, except share and per share data)** **Shares**  **Per Share**  **Term (Years)**  **Value** Options outstanding, December 31, 2007  510,000  $5.85         Options exercised  (60,000)  5.85                         Options outstanding, September 30, 2008  450,000   5.85   6.58  $1,206                Options exercisable, September 30, 2008  450,000   5.85   6.58  $1,206                **11. Income Taxes**     For the three months ended September 30, 2008 and 2007, the Company’s consolidated effectivetax rate was 41.8% and 46.6%, respectively. For the nine months ended September 30, 2008 and 2007,the Company’s consolidated annualized effective tax rate was 20.5% and 36.4%, respectively. As aresult of the FDA approval of the sNDA in April 2008 for irritable bowel syndrome with constipationand the related impact on projected income in 2008 and future years based on the $50.0 millionmilestone payment and expected product royalties, the Company believes that its U.S. deferred taxassets will likely be realized. Accordingly, the tax provision recorded during the nine monthsended September 30, 2008 reflects a discrete release of U.S. deferred tax asset valuationallowances of $4.8 million and a reduction in the projected 2008 effective tax rate applied to the2008 pre-tax income for the nine months ended September 30, 2008.
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)****12. Uncommitted Line of Credit**     On March 5, 2008, the Company entered into a line of credit providing for uncommittedborrowings of up to $30.0 million. The lender has no obligation to make advances under this line ofcredit but may do so in its sole discretion. The line of credit is collateralized by our currentand non-current investments. Advances made under this line of credit will bear an interest ratebased onLIBOR plus a predetermined percentage based on the amount of the advance and other conditions.Borrowings under this line of credit are due upon the demand of the lender and the lender can makea repayment demand at its sole option at any time for any or no reason. As of September 30, 2008,the Company had not drawn down any funds under this line of credit.**13. Segment Reporting**     The Company has determined that it has three reportable geographic segments based on theCompany’s method of internal reporting, which disaggregates business by geographic location. Thesesegments are the United States, Europe and Japan. The Company evaluates the performance of thesesegments based on income (loss) from operations, as well as other factors, including the progressof its research and development activities. The reportable segments have historically derived theirrevenue from joint collaboration and strategic alliance agreements. Transactions between thesegments consist primarily of intercompany loans and the provision of research and developmentservices. Following is a summary of financial information by reportable geographic segment.                                   **Intercompany**    **(In thousands)** **United States**  **Europe**  **Japan**  **Eliminations**  **Consolidated** **Three Months Ended September 30, 2008**                    Research and development revenue $5,436  $—  $—  $—  $5,436 Product royalty revenue  7,718   —   —   —   7,718 Co-promotion revenue  1,185   —   —   —   1,185 Contract and collaboration revenue  142   —   213   (213)  142                 Total revenues  14,481   —   213   (213)  14,481 Depreciation and amortization  110   1   3   —   114 Other operating expenses  17,819   469   1,100   (210)  19,178                 Loss from operations  (3,448)  (470)  (890)  (3)  (4,811)Interest income  678   1   2   (26)  655 Other non-operating expense, net  (6)  (17)  (21)  29   (15)                Loss before income taxes $(2,776) $(486) $(909) $—  $(4,171)                Capital expenditures $5  $35  $—  $—  $40                                      **Three Months Ended September 30, 2007**                    Research and development revenue $4,652  $—  $—  $—  $4,652 Product royalty revenue  6,998   —   —   —   6,998 Co-promotion revenue  1,051   —   —   —   1,051 Contract and collaboration revenue  142   —   219   (210)  151                 Total revenues  12,843   —   219   (210)  12,852 Depreciation and amortization  85   1   7   —   93 Other operating expenses  12,587   520   737   (210)  13,634                 Income (loss) from operations  171   (521)  (525)  —   (875)Interest income  782   —   3   (5)  780 Other non-operating income (expense), net  (69)  (16)  (148)  5   (228)                Income (loss) before income taxes $884  $(537) $(670) $—  $(323)                Capital expenditures $788  $—  $—  $—  $788                 
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**SUCAMPO PHARMACEUTICALS, INC.****Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)**                                   **Intercompany**    **(In thousands)** **United States**  **Europe**  **Japan**  **Eliminations**  **Consolidated** **Nine Months Ended September 30, 2008**                    Research and development revenue $66,982  $—  $—  $—  $66,982 Product royalty revenue  24,699   —   —   —   24,699 Co-promotion revenue  3,643   —   —   —   3,643 Contract and collaboration revenue  425   —   630   (630)  425                 Total revenues  95,749   —   630   (630)  95,749 Depreciation and amortization  318   1   7   —   326 Other operating expenses  55,324   2,891   4,537   (630)  62,122                 Income (loss) from operations  40,107   (2,892)  (3,914)  —   33,301 Interest income  1,924   6   5   (73)  1,862 Other non-operating (expense) income, net  (39)  (30)  (20)  73   (16)                Income (loss) before income taxes $41,992  $(2,916) $(3,929) $—  $35,147                 Capital expenditures $304  $35  $3  $—  $342                                      **Nine Months Ended September 30, 2007**                    Research and development revenue $52,105  $—  $—  $—  $52,105 Product royalty revenue  18,869   —   —   —   18,869 Co-promotion revenue  3,318   —   —   —   3,318 Contract and collaboration revenue  424   —   660   (630)  454                 Total revenues  74,716   —   660   (630)  74,746 Depreciation and amortization  143   1   9   —   153 Other operating expenses  52,201   829   1,671   (630)  54,071                 Income (loss) from operations  22,372   (830)  (1,020)  —   20,522 Interest income  1,573   —   7   (5)  1,575 Other non-operating income (expense), net  (64)  (25)  (108)  5   (192)                Income (loss) before income taxes $23,881  $(855) $(1,121) $—  $21,905                 Capital expenditures $2,128  $—  $—  $—  $2,128                                      **As of September 30, 2008**                    Property and equipment, net $2,167  $32  $84  $—  $2,283                 Identifiable assets $158,420  $2,160  $5,364  $(17,825) $148,119                 **As of December 31, 2007**                    Property and equipment, net $2,182  $—  $83  $—  $2,265                 Identifiable assets $114,490  $2,381  $1,987  $(8,831) $110,027                 
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**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**     *This Quarterly Report on**Form 10-Q**contains forward-looking statements regarding SucampoPharmaceuticals, Inc. (“Sucampo,” the “Company,” “we,” “us,” or “our”) and our business, financialcondition, results of operations and prospects within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Such forward-looking statements include those that express plans,anticipation, intent, contingency, goals, targets or future development and/or otherwise are notstatements of historical fact. These forward-looking statements are based on our currentexpectations and projections about future events and they are subject to risks and uncertaintiesknown and unknown that could cause actual results and developments to differ materially from thoseexpressed or implied in such statements. You should read the following discussion and analysis ofour financial condition and results of operations in conjunction with our consolidated financialstatements as of and for the year ended December 31, 2007 included in our Annual Report on Form10-K.***Overview**     We are a biopharmaceutical company focused on the discovery, development and commercializationof proprietary drugs based on prostones, a class of compounds derived from functional fatty acidsthat occur naturally in the human body. In January 2006, we received marketing approval from theU.S. Food and Drug Administration, or FDA, for our first product, AMITIZA, for the treatment ofchronic idiopathic constipation in adults. On April 29, 2008, the FDA approved AMITIZA for itssecond indication, the treatment of irritable bowel syndrome with constipation in women 18 years ofage or older.     We and Takeda Pharmaceutical Company Limited, or Takeda, are party to a collaboration andlicense agreement and a related supplemental agreement, or, collectively, the Takeda Agreements, tojointly develop and commercialize AMITIZA for chronic idiopathic constipation, irritable bowelsyndrome with constipation, opioid-induced bowel dysfunction and other gastrointestinal indicationsin the United States and Canada. We have the right to co-promote AMITIZA along with Takeda in thesemarkets. We and Takeda initiated commercial sales of AMITIZA in the United States for the treatmentof chronic idiopathic constipation in adults in April 2006. Under the Takeda Agreements, Takedarecords all product revenue and we receive a royalty on net product revenues for such sales.     Drs. Ryuji Ueno and Sachiko Kuno, our founders, own directly or indirectly the majorityholdings in Sucampo as well as in other companies that have contractual relationships with Sucampo.One of the founders serves as the Chairman of the Board of Directors, Chief Executive Officerand Chief Scientific Officer of Sucampo.     We hold an exclusive worldwide royalty-bearing license from Sucampo AG, or SAG, a Swisspatent-holding company and an entity wholly owned by our founders, to develop and commercializeAMITIZA and all other prostone compounds covered by patents and patent applications held by SAG. Weare obligated to assign to SAG all patentable improvements that we make in the field of prostones,which SAG is obligated in turn to license back to us on an exclusive basis. AMITIZA, cobiprostoneand SPI-017 are covered by perpetual licenses that cannot be terminated unless we default in ourpayment obligations to SAG. If we have not committed specified development efforts to any prostonecompound other than AMITIZA, cobiprostone and SPI-017 by the end of a specified period, which endson the later of June 30, 2011 or the date upon which Drs. Ryuji Ueno and Sachiko Kuno, ourfounders, no longer control our company, then the commercial rights to that compound will revert toSAG, subject to a 15-month extension in the case of any compound that we designate in good faith asplanned for development within that extension period.     We first generated product royalty revenue for commercial sales of AMITIZA in the secondquarter of 2006. Although we reported net income for the years ended December 31, 2007 and 2006, wehave historically incurred operating losses, resulting principally from costs incurred in ourresearch and development programs and from our general and administrative expenses. We expect tocontinue to incur significant and increasing expenses for the next several years as we continue toexpand our research and development activities, seek regulatory approvals for additionalindications for AMITIZA and for other compounds in the United States and abroad, expand ourinternational operations and augment our sales and marketing capabilities. While we expect futureprofitability, whether we are able to sustain profitability will depend upon our ability togenerate revenues and receive payments under our contracts with Takeda or similar futurearrangements. In the near term, our ability to generate product revenues will depend primarily onthe successful commercialization and continued development of additional indications for AMITIZA.
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     As a result of the FDA approval of AMITIZA for the treatment of the irritable bowel syndromewith constipation in women 18 years and older, we received a development milestone payment of $50.0million from Takeda in the second quarter of 2008 and we recognized the payment as research anddevelopment revenue. Consequently, in accordance with the restated license agreement withSAG, we paid and recorded as research and development expense a $2.5 million milestone royaltyto SAG during the nine months ended September 30, 2008, reflecting 5% of the $50.0 milliondevelopment milestone payment that we received from Takeda.**Our Clinical Development Programs**     We are developing prostone compounds for the treatment of a broad range of diseases. The mostadvanced of these programs are: **•** *AMITIZA (lubiprostone).*In connection with our marketing approval for AMITIZA for thetreatment of chronic idiopathic constipation in adults, we committed to the FDA to conductpost-marketing studies to evaluate the safety of the product in pediatric patients, inpatients with renal impairment and in patients with hepatic impairment, which wereinitiated in January 2007. In connection with our marketing approval for AMITIZA for thetreatment of irritable bowel syndrome with constipation in adult women, we committed to theFDA to conduct a post-marketing study to evaluate the safety and efficacy for the treatmentof irritable bowel syndrome in pediatric patients ages 6 to 17. In addition, we committedto conduct a post-marketing study in male and female patients with irritable bowel syndromewith constipation utilizing a higher dose than currently recommended for this indication.We are also developing AMITIZA to treat opioid-induced bowel dysfunction. We commencedPhase III pivotal clinical trials of AMITIZA for the treatment of opioid-induced boweldysfunction in September 2007 and we expect to complete these trials by the end of 2009 andfile the supplemental new drug application (sNDA) with the FDA in 2010. Our collaborationand co-promotion arrangement with Takeda also covers these additional indications forAMITIZA and Takeda funds a majority of AMITIZA’s development program in the United States.    In February 2008, we submitted a Marketing Approval Application, or MAA, for lubiprostone, 24micrograms, or mcg, for the indication of chronic idiopathic constipation in adults in theUnited Kingdom. The MAA was submitted using the decentralized procedure with the UnitedKingdom, through its Medicines and Healthcare Products Regulatory Agency, serving as thereference member state, with additional applications subsequently submitted to the memberstates of Belgium, Denmark, France, Germany, Ireland, the Netherlands, Spain and Sweden. InMay 2008, we received notification that all of the MAAs have been received and validated bythe individual regulatory agencies. In June 2008, we submitted a MAA for lubiprostone, 24micrograms, for the indication of chronic idiopathic constipation in adults in Switzerland.    In September 2008, we announced positive results from our multi-center Phase 2b dose-rangingstudy in Japan to evaluate the safety and efficacy of lubiprostone for treating chronicidiopathic constipation in adults. We plan to initiate Phase III clinical trials in Japan inmid-2009.  **•** *Cobiprostone.*We are developing orally administered cobiprostone to treat variousgastrointestinal and liver disorders, including non-steroidal anti-inflammatorydrug-induced ulcers, portal hypertension, non-alcoholic fatty liver disease andgastrointestinal disorders associated with cystic fibrosis. We also are planning to developan inhaled formulation of cobiprostone for the treatment of respiratory symptoms of cysticfibrosis and chronic obstructive pulmonary disease. Our near term focus is on thedevelopment of cobiprostone as a treatment for non-steroidal anti-inflammatory drug-inducedulcers. We commenced a Phase II clinical trial of cobiprostone for the treatment ofnon-steroidal anti-inflammatory drug-induced ulcers in the third quarter of 2007. We expectto enroll approximately 120 patients in this clinical trial, which we plan to complete inmid-2009. We also initiated a Phase II proof-of-concept study of cobiprostone for thetreatment of portal hypertension in patients with liver cirrhosis in July 2008 and weexpect to complete the trials by the end of 2009.  **•** *SPI-017.*We are developing SPI-017 to treat vascular disease and central nervous systemdisorders. We are initially focused on developing an intravenous formulation of thisproduct candidate for the treatment of peripheral arterial disease. We also are developingan oral formulation of SPI-017 for the treatment of Alzheimer’s disease and a topicalformulation for wound healing. We plan to initiate Phase I clinical trials of theintravenous and oral formulation of SPI-017 by the end of 2008.
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**Results of Operations*****Reclassifications***     We have reclassified certain amounts in the previously issued financial statements to conformwith the current presentation. We reclassified expenses that have been previously included withingeneral and administrative expenses to research and development expenses. Such expenses primarilyinclude salaries and other employee benefits of personnel who oversee research and developmentprojects, and allocated depreciation and rent expenses and insurance costs. We also reclassifiedallocated depreciation and rent expenses and insurance costs from general and administrativeexpenses to selling and marketing expenses. During the three monthsended September 30, 2007, we reclassified $828,000 and $84,000 of general and administrativeexpenses to research and development expenses and selling and marketing expenses, respectively.During the nine months ended September 30, 2007, we reclassified approximately $2.2 million and$154,000 of general and administrative expenses to research and development expenses and sellingand marketing expenses, respectively.***Comparison of three months ended September 30, 2008 and September 30, 2007******Revenues***     The following table summarizes our revenues for the three months ended September 30, 2008 and2007:           **Three Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Research and development revenue $5,436  $4,652 Product royalty revenue  7,718   6,998 Co-promotion revenue  1,185   1,051 Contract and collaboration revenue  142   151        Total $14,481  $12,852             Total revenues were $14.5 million for the three months ended September 30, 2008 compared to$12.9 million for the three months ended September 30, 2007, an increase of $1.6 million or 12.4%.     Research and development revenue was $5.4 million for the three months ended September 30,2008 compared to $4.7 million for the three months ended September 30, 2007, an increase of $0.7million or 14.9%. This increase was primarily due to revenue recognized related to the on-goingopioid-induced bowel dysfunction Phase III pivotal trials funded by Takeda. During the three monthsended September 30, 2008, we deferred an additional $1.9 million of research and developmentrevenue as a result of a change, in the second quarter of 2008, in the estimated completion dateand an increase in total expected reimbursable costs associated with these trials.     Product royalty revenue represents royalty revenue earned on net sales of AMITIZA inaccordance with the Takeda Agreements. For the three months ended September 30, 2008 and 2007, werecognized $7.7 million and $7.0 million, respectively, of product royalty revenue, an increase of$0.7 million or 10%. The increase reflects the continuing acceptance by patients and physicians ofAMITIZA® 24 mcg for the treatment of chronic idiopathic constipation in adults and salesof AMITIZA 8 mcg for irritable bowel syndrome with constipation in adult women. The product royaltyrevenue for the three months ended September 30, 2008 was also burdened somewhat by lowerrestocking orders for AMITIZA 8 mcg reflecting the draw-down of the inventory from the initialstocking of AMITIZA 8 mcg completed during the second quarter of 2008. We recognized royalty ofapproximately $1.9 million in the second quarter of 2008 for the portion of the 8 mcg product withno right of return. Additionally, during the three months ended September 30, 2008, we recorded areduction of product royalty revenues of $644,000 resulting from a change in estimate relating torebates, discounts and other expenses.     Co-promotion revenues represent reimbursement by Takeda of certain co-promotion costs for ourspecialty sales force and costs associated with miscellaneous marketing activities in connectionwith the commercialization of AMITIZA. For the three months ended September 30, 2008 and 2007, werecognized $1.2 million and $1.1 million, respectively, of co-promotion revenues for reimbursementof sales force costs.***Research and Development Expenses***
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     The following summarizes our research and development expenses for the three months endedSeptember 30, 2008 and 2007:           **Three Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Direct costs:        AMITIZA $8,166  $5,563 Cobiprostone  1,180   875 SPI - 017  616   278 Other  749   458        Total  10,711   7,174                 Indirect costs  679   414        Total $11,390  $7,588             Total research and development expenses for the three months ended September 30, 2008 were$11.4 million compared to $7.6 million for the three months ended September 30, 2007, an increaseof $3.8 million or 50%. This increase was due to our on-going clinical development programs ofAMITIZA for the treatment of opioid-induced bowel dysfunction, chronic idiopathic constipation inJapan and cobiprostone for the treatment of non-steroidal anti-inflammatory drug-induced ulcers andportal hypertension in patients with liver cirrhosis, and preclinical and basic development costsassociated with SPI-017.***General and Administrative Expenses***     The following summarizes our general and administrative expenses for the three months endedSeptember 30, 2008 and 2007:           **Three Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Salaries, benefits and related costs $1,156  $882 Legal and consulting expenses  852   638 Stock-based compensation  51   9 Founders’ stock-based award  —   (1,000) Other operating expenses  1,804   1,587        Total $3,863  $2,116             General and administrative expenses were $3.9 million for the three months ended September 30,2008 compared to $2.1 million for the three months ended September 30, 2007, an increase of $1.8million or 85.7%. This increase was primarily due to an adjustment to the founders’ stock-basedaward during the three months ended September 30, 2007 and due to an increase in operationalheadcount, an increase in expenses associated with our new office space and an increase in overallcosts associated with the compliance and regulatory requirements of being a publicly traded companywith international operations for the three months ended September 30, 2008.***Selling and Marketing Expenses***     Selling and marketing expenses represent costs we incur to co-promote AMITIZA, includingsalaries, benefits and related costs of our sales force and other sales and marketing personnel,costs of market research and analysis and other selling and marketing expenses. Selling andmarketing expenses were $2.7 million for the three months ended September 30, 2008 compared to $2.8million for the three months ended September 30, 2007, a decrease of $0.1 million or 3.6%. Thedecrease was primarily due to reduced marketing expenses in the long-term care market, which wesupport with our internal sales force.***Product Royalties — Related Parties***     Product royalties — related parties expense represent 3.2% of AMITIZA net sales for therespective periods payable to SAG and increased to $1.4 million for the three months endedSeptember 30, 2008 from $1.2 million for the three months ended September 30 2007 in line with theincrease of product royalty revenue.
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***Non-Operating Income and Expense***     The following table summarizes our non-operating income and expense for the three months endedSeptember 30, 2008 and 2007:           **Three Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Interest income $655  $780 Other expense, net  (15)  (228)       Total non-operating income, net $640  $552             Interest income was $655,000 for the three months ended September 30, 2008 compared to$780,000 for the three months ended September 30, 2007, a decrease of $125,000 or 16.0%. Thedecrease was primarily due to a decrease in yield earned by our investments as we moved ourinvestment portfolio mix from auction rate securities to U.S. Government securities.***Income Taxes***     For the three months ended September 30, 2008 and 2007, our consolidated effective tax ratewas 41.8% and 46.6%, respectively. For the three months ended September 30, 2008, we recorded a taxbenefit of $1.7 million. For the three months ended September 30, 2007, we recorded a tax provisionof $151,000.***Comparison of nine months ended September 30, 2008 and September 30, 2007******Revenues***     The following table summarizes our revenues for the nine months ended September 30, 2008 and2007:           **Nine Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Research and development revenue $66,982  $52,105 Product royalty revenue  24,699   18,869 Co-promotion revenue  3,643   3,318 Contract and collaboration revenue  425   454        Total $95,749  $74,746             Total revenues were $95.7 million for the nine months ended 2008 compared to $74.7 million forthe nine months ended September 30, 2007, an increase of $21.0 million or 28.1%.     Research and development revenue was $67.0 million for the nine months ended September 30,2008 compared to $52.1 million for the nine months ended September 30, 2007, an increase of $14.9million or 28.6%. The increase was primarily due to the $50.0 million development milestone earnedand received from Takeda in May 2008 upon FDA approval of AMITIZA for the treatment of theirritable bowel syndrome with constipation in adult women compared to the $30.0 million developmentmilestone earned from Takeda upon filing of the sNDA for AMITIZA to treat irritable bowel syndromewith constipation in June 2007. The increase was partially offset by a deferral of approximately$3.6 million in research and development revenue as a result of a change in the second quarter of2008 of the estimated completion date and an increase in total expected reimbursable costsassociated with the ongoing clinical trials for opioid-induced bowel dysfunction. The increase inresearch and development revenue was partly offset by the recognition of $11.0 million ofAMITIZA-related deferred revenue during the first six months of 2007 resulting from paymentspreviously received from Takeda for development of AMITIZA to treat chronic idiopathic constipationand irritable bowel syndrome with constipation. We recognized revenue for this development workratably over the estimated performance period, which was completed in June 2007 when we filed thesNDA for the irritable bowel syndrome with constipation indication, and there is no correspondingamount in 2008.     Product royalty revenue represents royalty revenue earned on net sales of AMITIZA inaccordance with the Takeda Agreements. For the nine months ended September 30, 2008 and 2007, werecognized $24.7 million and $18.9 million, respectively, of product royalty revenue, an increaseof $5.8 million or 30.7%. The increase reflects the continuing acceptance by patients andphysicians of AMITIZA® 24 mcg for the treatment of chronic idiopathic constipation inadults and sales of AMITIZA 8 mcg for irritable bowel syndrome with constipation in adult women,including the royalty revenue of approximately $1.9 million recognized during the three monthsended June 30, 2008 from the initial stocking of AMITIZA 8 mcg in May 2008. Additionally, duringthe nine months endedSeptember 30, 2008, we recorded a reduction of product royalty revenues of $644,000 resultingfrom a change in estimate relating to rebates, discounts and other expenses.
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     Co-promotion revenues represent reimbursement by Takeda of co-promotion costs for ourspecialty sales force and costs associated with miscellaneous marketing activities in connectionwith the commercialization of AMITIZA. For the nine months ended September 30, 2008 and 2007, werecognized $3.6 million and $3.3 million, respectively, of co-promotion revenues for reimbursementof sales force costs.***Research and Development Expenses***     The following summarizes our research and development expenses for the nine months endedSeptember 30, 2008 and 2007:           **Nine Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Direct costs:        AMITIZA $27,192  $16,272 Cobiprostone  3,450   3,101 SPI - 017  2,232   1,033 Other  1,048   863        Total  33,922   21,269          Indirect costs  1,615   1,009        Total $35,537  $22,278             Total research and development expenses for the nine months ended September 30, 2008 were$35.5 million compared to $22.3 million for the nine months ended September 30, 2007, an increaseof $13.2 million or 59.2%. This increase was due to our ongoing clinical development programs ofAMITIZA for the treatment of opioid-induced bowel dysfunction, chronic idiopathic constipation inJapan and cobiprostone for the treatment of non-steroidal anti-inflammatory drug-induced ulcers andportal hypertension in patients with liver cirrhosis, and preclinical and basic development costsassociated with SPI-017. We also incurred filing and data purchase costs of approximately $2.5million, which were necessary to submit our European MAAs during the nine months ended September30, 2008.***General and Administrative Expenses***     The following summarizes our general and administrative expenses for the nine months endedSeptember 30, 2008 and 2007:           **Nine Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Salaries $3,277  $2,772 Legal and consulting expenses  2,101   2,005 Stock-based compensation  153   (194)Founders’ stock-based award  —   9,187 Other  5,060   3,516        Total $10,591  $17,286             General and administrative expenses were $10.6 million for the nine months ended September 30,2008 compared to $17.3 million for the nine months ended September 30, 2007, a decrease of $6.7million or 38.7%. This decrease was primarily due to a one-time expense of $9.2 million related toa stock-based award granted to the founders recorded in 2007, partially offset by an increase inoperational headcount, an increase in expenses associated with our new office space and an increasein overall costs associated with the compliance and regulatory requirements of being a publiclytraded company with international operations.
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***Selling and Marketing Expenses***     Selling and marketing expenses represent costs we incur to co-promote AMITIZA, includingsalaries, benefits and related costs of our sales force and other sales and marketing personnel,costs of market research and analysis and other selling and marketingexpenses. Selling and marketing expenses were $8.4 million for the nine months ended September30, 2008 compared to $9.8 million for the nine months ended September 30, 2007, a decrease of $1.4million or 14.3%. This decrease was primarily due to cost savings related to completing our initialbuild-out of our own internal dedicated sales force to provide AMITIZA to patients in long-termcare facilities, as well as in medical schools and university hospitals, which was completed duringthe second quarter of 2007 and reduced marketing expenses in the long-term care market.***Milestone Royalties — Related Parties***     Milestone royalties — related parties expense was $3.5 million for the nine months endedSeptember 30, 2008. We are obligated to pay SAG a $1.0 million milestone in connection with ourfirst NDA filing, or comparable foreign regulatory filing, such as an MAA, in each of the threefollowing territories covered by the license agreement with SAG: North, Central and South America(including the Caribbean); Asia; and the rest of the world. Our MAA filed in February 2008represented the first such filing for the rest-of-the-world territory. As a result of our sNDAapproval for AMITIZA to treat irritable bowel syndrome with constipation, we paid SAG $2.5 million,reflecting 5% of the $50.0 million development milestone payment that we received from Takeda inMay 2008. We recorded $1.5 million in milestone royalties — related parties expense for the ninemonths ended September 30, 2007, reflecting the 5% we owed SAG in respect of the $30.0 milliondevelopment milestone earned from Takeda during that period upon the filing of our sNDA.***Product Royalties — Related Parties***     Product royalties — related parties expense was $4.4 million for the nine months endedSeptember 30, 2008 compared to $3.4 million for the nine months ended September 30, 2007, anincrease of $1.0 million or 29.4%, in line with the increase of product royalty revenue.***Non-Operating Income and Expense***     The following table summarizes our non-operating income and expense for the nine months endedSeptember 30, 2008 and 2007:           **Nine Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Interest income $1,862  $1,575 Other expense, net  (16)  (192)       Total non-operating income, net $1,846  $1,383             Interest income was $1.9 million for the nine months ended September 30, 2008 compared to $1.6million for the nine months ended September 30, 2007, an increase of $0.3 million or 18.8%. Theincrease was primarily due to an increase in the funds available for investment in 2008 compared to2007, partially offset by a decrease in yield earned by our investments as our investment portfoliomix moved from auction rate securities to U.S. Government securities.***Income Taxes***     For the nine months ended September 30, 2008 and 2007, our consolidated effective tax rate was20.5% and 36.4%, respectively. For the nine months ended September 30, 2008 and 2007, we recorded atax provision of $7.2 million and $7.9 million, respectively. As a result of the FDA approval ofthe sNDA for irritable bowel syndrome with constipation in adult women and the related impact onprojected income in 2008 and future years from the $50.0 million milestone payment received in May2008 and expected product royalties, we believe that our U.S. deferred tax assets will likely berealized. Accordingly, the tax provision recorded for the nine months ended September 30, 2008reflects a discrete release of U.S. deferred tax asset valuation allowances of $4.8 million and areduction in the projected 2008 effective tax rate applied to our pre-tax income.**Reportable Geographic Segments**     We have determined that we have three reportable geographic segments based on our method ofinternal reporting, which disaggregates business by geographic location. These segments are theUnited States, Europe and Japan. We evaluate the performance of these segments based on income(loss) from operations, as well as other factors, including the progress of research anddevelopment activities. The following is a summary of financial information by reportable segment.
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                                   **Intercompany**  **(In thousands)** **United States** **Europe** **Japan** **Eliminations** **Consolidated****Three Months Ended September 30, 2008**                    Total revenues $14,481  $—  $213  $(213) $14,481 Loss from operations  (3,448)  (470)  (890)  (3)  (4,811)                     **Three Months Ended September 30, 2007**                    Total revenues $12,843  $—  $219  $(210) $12,852 Income (loss) from operations  171   (521)  (525)  —   (875)                     **Nine Months Ended September 30, 2008**                    Total revenues $95,749  $—  $630  $(630) $95,749 Income (loss) from operations  40,107   (2,892)  (3,914)  —   33,301                      **Nine Months Ended September 30, 2007**                    Total revenues $74,716  $—  $660  $(630) $74,746 Income (loss) from operations  22,372   (830)  (1,020)  —   20,522                      **Identifiable Assets**                    At September 30, 2008 $158,420  $2,160  $5,364  $(17,825) $148,119 At December 31, 2007  114,490   2,381   1,987   (8,831)  110,027 **Liquidity and Capital Resources*****Sources of Liquidity***     We require cash principally to meet our operating expenses. We have financed our operationswith a combination of private placements of equity securities, our initial public offering,up-front payment, milestone and royalty payments and research and development expensereimbursements received from Takeda and R-Tech Ueno, Ltd., a Japanese pharmaceutical manufacturerand affiliate. We have raised net proceeds of $55.3 million from private equity financings and netproceeds of $28.2 million from our initial public offering. We have also received an aggregate of$215.3 million in up-front, milestone and expense reimbursement payments from Takeda.     Our cash, cash equivalents and investments consist of the following assets at fair value:           **September 30,**  **December 31,** **(In thousands)** **2008**  **2007** Cash and cash equivalents $13,364  $25,559 Investments, current  93,117   51,552 Investments, non-current  17,626   9,400          $124,107  $86,511             Our cash and cash equivalents are deposits in operating accounts and highly liquid investmentswith an original maturity at time of purchase of 90 days or less.     At September 30, 2008, we continue to hold $21.0 million of investments in auction ratesecurities at fair value and recorded an unrealized loss of $1.9 million, or $1.2 million net oftax effect, as of September 30, 2008, related to these investments. This unrealized loss wasrecorded as other comprehensive loss during the nine months ended September 30, 2008.     On October 16, 2008, we accepted the settlement rights offered by our broker under asettlement agreement between the broker and the SEC and various state regulatory authorities. Thesettlement rights allow us to redeem auction rate securities at par within a specified period.Based on this settlement, we received $3.4 million on November 3, 2008, representing the par valueof our tax-exempt auction rate securities, and we have the right to request the redemption of theremaining auction rate securities at par value of an additional $19.4 million within the two-yearperiod starting June 30, 2010. As the settlement was accepted subsequent to September 30, 2008, ourconsolidated financial statements as of September 30, 2008 do not reflect any contingent gains,valuation adjustments or any other amounts relating to the settlement rights. We have, however,classified auction rate securities as current andnon-current investments as of September 30, 2008 based on the expected redemption dates. We donot anticipate having to sell these securities in order to operate its business before the expectedredemption dates.
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     On March 5, 2008, we entered into a line of credit providing for uncommitted borrowings of upto $30.0 million. The lender has no obligation to make advances under this line of credit but maydo so in its sole discretion. The line of credit is collateralized by our current and non-currentinvestments. Advances made under this line of credit will bear an interest rate based on LIBOR plusa predetermined percentage based on the amount of the advance and other conditions. Borrowingsunder this line of credit are due upon the demand of the lender and the lender can make a repaymentdemand at its sole option at any time for any or no reason. As of September 30, 2008, we had notdrawn down any funds under this line of credit.***Cash Flows***     The following table summarizes our cash flows for the nine months ended September 30, 2008 and2007:           **Nine Months Ended**   **September 30,** **(In thousands)** **2008**  **2007** Cash (used in) provided by:        Operating activities $38,611  $8,408 Investing activities  (51,801)  (33,180)Financing activities  1,025   31,341 Effect of exchange rates  (30)  186        Net (decrease) increase in cash and cash equivalents $(12,195) $6,755        ***Nine Months Ended September 30, 2008***     Net cash provided by operating activities was $38.6 million for the nine months endedSeptember 30, 2008 and reflected net income of $28.0 million, a change of $3.2 million in netprepaid and income taxes receivable and payable, an increase in accrued expenses of $3.8 millionand an increase of $4.9 million in deferred revenue, offset by a non-cash reversal of deferred taxasset valuation allowances of $4.3 million and changes in other operating assets and liabilities.     Net cash used in investing activities of $51.8 million for the nine months ended September 30,2008 primarily reflected our net purchases of investments as a result of our investment of the$50.0 million milestone payment received from Takeda in the second quarter of 2008.     Net cash provided by financing activities of $1.0 million for the nine months ended September30, 2008 resulted from the exercise of stock options.***Nine Months Ended September 30, 2007***     Net cash provided by operating activities was $8.4 million for the nine months ended September30, 2007. This reflected net income of $13.9 million, which was offset by an increase in productroyalties receivable of $5.0 million, an increase in accounts receivable of $2.8 million and adecrease in deferred revenue of $11.4 million. The decrease in deferred revenue primarily relatedto the amortization of deferred research and development revenue over the performance period of thedevelopment of AMITIZA.     Net cash used in investing activities of $33.2 million for the nine months ended September 30,2007 primarily reflected our net purchases of investments as a result of our investment of the$30.0 million milestone payment received from Takeda in the second quarter of 2007 andapproximately $2.1 million of purchases of property and equipment associated with the move of ouroffices in the United States in July 2007.     Net cash provided by financing activities was $31.3 million for the nine months endedSeptember 30, 2007 and reflected primarily proceeds from our initial public offering, net ofcertain offering costs.***Off-Balance Sheet Arrangements***
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     We do not have any off-balance sheet arrangements, as such term is defined in Item 303(a)(4)of Regulation S-K promulgated under the Securities Act of 1933, as amended.***Funding Requirements***     We will need substantial amounts of capital to continue growing our business. We will requirethis capital to: **•** fund our 30% share of the two post-marketing studies of AMITIZA to evaluate its safetyin patients with renal impairment and patients with hepatic impairment;  **•** fund regulatory efforts in Europe and Japan for AMITIZA;  **•** fund development and regulatory activities for cobiprostone and SPI-017;  **•** fund research and development activities for prostone compounds other than AMITIZA,cobiprostone and SPI-017;  **•** fund the expansion of our commercialization activities in the United States and theinitiation of commercialization efforts in non-U.S. markets; and  **•** fund costs for capital expenditures to support the growth of our business.     The timing of these funding requirements is difficult to predict due to many factors,including the outcomes of our research and development programs and when those outcomes aredetermined, the timing of obtaining regulatory approvals and the presence and status of competingproducts. Our capital needs may exceed the capital available from our future operations,collaborative and licensing arrangements and existing liquid assets. Our future capitalrequirements and liquidity will depend on many factors, including, but not limited to: **•** the revenue from AMITIZA;  **•** the future expenditures we may incur to increase revenue from AMITIZA;  **•** the cost and time involved to pursue our research and development programs;  **•** our ability to establish collaborative arrangements and to enter into licensingagreements and contractual arrangements with others; and  **•** any future change in our business strategy.     To the extent that our capital resources may be insufficient to meet our future capitalrequirements, we may need to finance our future cash needs through public or private equityofferings, debt financings or corporate collaboration and licensing arrangements.     Additional equity or debt financing, grants or corporate collaboration and licensingarrangements may not be available on acceptable terms, if at all. If adequate funds are notavailable, we may be required to delay, reduce the scope of or eliminate our research anddevelopment programs, reduce our planned commercialization efforts or obtain funds througharrangements with collaborators or others that may require us to relinquish rights to certainproduct candidates that we might otherwise seek to develop or commercialize independently. Inaddition, any future equity funding may dilute the ownership of our equity investors.***Recent Accounting Pronouncements***     Recent accounting pronouncements applicable to our financial statements are described in Note2 to our condensed consolidated financial statements.
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**Item 3.*****Quantitative and Qualitative Disclosures about Market Risk***     We do not use derivative financial instruments for trading or speculative purposes. However,we regularly invest excess cash in overnight deposits that are subject to changes in short-terminterest rates.     Our exposure to market risks associated with changes in interest rates relates primarily tothe increase or decrease in the amount of interest income earned on our investment portfolio. Wemitigate default risk by investing in investment grade securities. A hypothetical one percentagepoint adverse move in interest rates along the entire interest rate yield curve would not havematerially affected the fair value of our interest sensitive financial instruments as of September30, 2008.     Our exposure to credit risk consists of cash and cash equivalents, restricted cash investmentsand receivables. We place our cash and cash equivalents, restricted cash and investments withhighly rated financial institutions. Our uninsured cash, cash equivalents and investments as ofSeptember 30, 2008 consist primarily of $70.8 million of U.S. Treasury and notes and $18.9 millionof money market funds guaranteed under the U.S. Treasury’s Temporary Guarantee Program.       **September 30,** **(In thousands)** **2008** Cash and cash equivalents $13,364 Investments  110,743 Restricted cash  213 Less: amounts subject to federally insured limits  (26,239)    Total amounts in excess of federally insured limits $98,081          Our investments in the auction rate securities and related risks are further described in PartI, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources.”**Item 4.*****Controls and Procedures*****a) Evaluation of Disclosure Controls and Procedures**     Our management, under the supervision and with the participation of our Principal ExecutiveOfficer and Principal Financial Officer, performed an evaluation of the effectiveness of the designand operation of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended) as of September 30, 2008. Based uponthis evaluation, our Principal Executive Officer and Principal Financial Officer have concludedthat, as of September 30, 2008, our disclosure controls and procedures were effective to providereasonable assurance that the information required to be disclosed is recorded, processed,summarized and reported within the time periods specified under applicable rules of the Securitiesand Exchange Commission, and that such information is accumulated and communicated to management,including our Principal Executive Officer and Principal Financial Officer, as appropriate, to allowtimely decisions regarding required disclosures.**b) Changes in Internal Controls**     There were no changes in our internal control over financial reporting during the quarterended September 30, 2008 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.**Part II — OTHER INFORMATION****Item 1.*****Legal Proceedings***     We are not currently a party to any legal proceedings of which the ultimate outcome, in ourjudgment, would have a material adverse effect on our business, financial condition or results ofoperations.**Item 1A.*****Risk Factors***     Except for the risk factors listed below, we do not believe there have been material changesto the risk factors affecting our business that we included in our Annual Report on Form 10-K forthe year ended December 31, 2007.
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***The recent downturn in the global economy and the recent pressure on capital markets increase thepossibility of and may exacerbate the impact of any adverse effects on our financial position andbusiness prospects.***     The recent downturn in the U.S. economy and economics around the world and the extraordinarypressure being placed on both debt and equity markets have led to significant retraction in theU.S. businesses, sudden and severe decreases in the prices of U.S. equities generally and a severeshortage in available credit. These factors have made it more difficult, in general, for companiesto expand or maintain their current operations and have increased the likelihood that certaincompanies will fail. Although we cannot say with certainty the impact the current economic criseshas had on us to date or may have on us in the future, continued pressure on the U.S. economy andits capital markets may have the effect of, among other things, reducing demand for our productsgenerally, increasing the cost to manufacture our products, or making it more difficult for us toraise capital or enter into strategic relationships, each of which could have a materially negativeimpact on our business or business prospects. The economic downturn may also lead to, oraccelerate, a decrease in the trading price of our class A common stock.***We depend significantly upon Takeda’s sales force to market AMITIZA. In addition to its own salesforce, Takeda has been utilizing a sales force within an affiliated joint venture for this purpose,and the joint venture was recently terminated. Any disruptions in the marketing of AMITIZA by theTakeda sales force as a result of this development could cause a decline in our revenues.***     Under our collaboration and license agreement with Takeda Pharmaceutical Company Limited, orTakeda, Takeda markets AMITIZA broadly to office-based specialty physicians and primary carephysicians. For this purpose, Takeda has been utilizing its own sales force and a sales forcewithin an affiliated joint venture, TAP Pharmaceutical Products, Inc., or TAP, which Takeda jointlyowned with Abbot Pharmaceuticals, or Abbott. Takeda and Abbott recently announced that they haveterminated the TAP joint venture. Takeda has informed us that the TAP sales force marketing AMITIZAwill become a Takeda sales force following the termination of the joint venture. These developmentscould cause some short-term distraction and dislocation in the Takeda sales force promotingAMITIZA, which could cause some disruption in the marketing of AMITIZA and in turn lead todeclining or deferred sales of AMITIZA. While we expect any such disruptions would be temporary andshort-term, we cannot assure you that will be the case. Any longer-term disruptions could cause amaterial decline in our revenues.***The resignations of our chief financial officer, our vice president of business development andcompany operations and our executive vice president of commercial operations could be disruptive toour business, and our inability to replace them on a timely basis could compromise our ability tomanage our company.***     Mariam E. Morris, our former chief financial officer, resigned her position with us effectiveJuly 31, 2008. Kei S. Tolliver, our former vice president of business development and companyoperations, resigned her position effective as of May 31, 2008. In addition, Brad Fackler, ourexecutive vice president, commercial operations, resigned his position effective as of October 10,2008 and agreed to remain as an employee at Sucampo for a period of time to assist in thetransition of responsibilities. Our failure to successfully transition the responsibilities ofthese employees to other employees could make it difficult for us to pursue our business strategy.
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**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds*****Use of Proceeds from Initial Public Offering of Class A Common Stock***     In August 2007, we completed an initial public offering of class A common stock pursuant to aregistration statement on Form S-1 (Registration No. 333-135133) which the Securities and ExchangeCommission, or SEC, declared effective on August 2, 2007. Pursuant to the registration statement,we registered the offering and sale of an aggregate of 4,312,500 shares of our class A commonstock, of which 3,125,000 shares were sold by us and 625,000 shares were sold by a sellingstockholder, at a price of $11.50 per share. S&R Technology Holdings, LLC, or S&R, which is whollyowned by our founders, Drs. Kuno and Ueno, granted to the underwriters an option to purchase anadditional 562,500 shares of our class A common stock at the initial public offering price of$11.50 per share to cover over-allotments, if any. The initial closing of the offering occurred onAugust 2, 2007. The underwriters exercised their over-allotment option and purchased an additional562,500 shares of class A common stock from S&R on August 29, 2007. We did not receive any proceedsfrom the sale of these shares by S&R. The managing underwriters for the offering were Cowen andCompany, LLC, CIBC World Markets Corp. and Leerink Swann & Co., Inc.     We raised a total of $28.2 million in net proceeds from our initial public offering. We havenot used any of the net proceeds from the offering to make payments, directly or indirectly, to anydirector or officer of ours, or any of their associates, to any person owning 10% or more of ourcommon stock or to any affiliate of ours, and none of the expenses we incurred in connection withthe offering or the underwriting discounts and commissions were paid, directly or indirectly, toany such persons. We did, however, contemporaneously with the closing of our initial publicoffering, make payments of approximately $3.1 million in the aggregate to Ryuji Ueno, a director,officer and 10% stockholder, and Sachiko Kuno, a 10% stockholder, in settlement of special stockand cash awards that had been made to them in June 2007.     We have used all proceeds from our initial public offering in line with the use of proceeds asdescribed in our final prospectus filed with the SEC pursuant to Rule 424(b) under the SecuritiesAct.**Item 3.*****Defaults Upon Senior Securities.***     None.**Item 4.*****Submission of Matters to a Vote of Security Holders***     No matters were submitted to a vote of security holders during the quarter ended September 30,2008.**Item 5.*****Other Information.***     None.
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**Item 6. Exhibits****(a) Exhibits**     **Exhibit**    **Number** **Description** **Reference** 3.1 Restated Certificate of Incorporation Exhibit 3.1 to theCompany’s CurrentReport on Form 8-K(filed August 8,2007)     3.2 Form of Restated Bylaws Exhibit 3.4 toRegistrationStatement No.333-135133, AmendmentNo. 2 (filed October20, 2006)     4.1 Specimen Stock Certificate evidencingthe shares of class A common stock Exhibit 4.1 toRegistrationStatement No.333-135133, AmendmentNo. 5 (filed February1, 2007)     10.1 Indemnification Agreement by andbetween the Company and Andrew J.Ferrara Exhibit 10.1 to theCompany’s CurrentReport on Form 8-K(filed July 22, 2008)     10.2 Separation Agreement and GeneralRelease by and between the Company andMariam E. Morris Exhibit 10.1 to theCompany’s CurrentReport on Form 8-K(filed July 28, 2008)     10.3 Consulting Agreement by and betweenthe Company and Mariam E. Morris Exhibit 10.2 to theCompany’s CurrentReport on Form 8-K(filed July 28, 2008)     31.1 Certification of the PrincipalExecutive Officer, as required bySection 302 of the Sarbanes-Oxley Actof 2002 Included herewith     31.2 Certification of the PrincipalFinancial Officer, as required bySection 302 of the Sarbanes-Oxley Actof 2002 Included herewith     32.1 Certification of the PrincipalExecutive Officer pursuant to 18U.S.C. Section 1350, as adoptedpursuant to Section 906 of theSarbanes-Oxley Act of 2002 Included herewith     32.2 Certification of the PrincipalFinancial Officer pursuant to 18U.S.C. Section 1350, as adoptedpursuant to Section 906 of theSarbanes-Oxley Act of 2002 Included herewith
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**SIGNATURES**     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.         Sucampo Pharmaceuticals, Inc.            November 14, 2008 By: /s/ RYUJI UENO Ryuji Ueno, M.D., Ph.D., Ph.D.      Chief Executive Officer, Chief Scientific Officer      and Chairman of the Board of Directors      (Principal Executive Officer)              November 14, 2008 By: /s/ JAN SMILEK Jan Smilek      Vice President, Finance and Acting Chief      Financial Officer      (Principal Financial Officer)  
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**Sucampo Pharmaceuticals, Inc.****Exhibit Index**     **Exhibit**    **Number** **Description** **Reference** 3.1 Restated Certificate of Incorporation Exhibit 3.1 to theCompany’s CurrentReport on Form 8-K(filed August 8,2007)     3.2 Form of Restated Bylaws Exhibit 3.4 toRegistrationStatement No.333-135133, AmendmentNo. 2 (filed October20, 2006)     4.1 Specimen Stock Certificate evidencingthe shares of class A common stock Exhibit 4.1 toRegistrationStatement No.333-135133, AmendmentNo. 5 (filed February1, 2007)     10.1 Indemnification Agreement by andbetween the Company and Andrew J.Ferrara Exhibit 10.1 to theCompany’s CurrentReport on Form 8-K(filed July 22, 2008)     10.2 Separation Agreement and GeneralRelease by and between the Company andMariam E. Morris Exhibit 10.1 to theCompany’s CurrentReport on Form 8-K(filed July 28, 2008)     10.3 Consulting Agreement by and betweenthe Company and Mariam E. Morris Exhibit 10.2 to theCompany’s CurrentReport on Form 8-K(filed July 28, 2008)     31.1 Certification of the PrincipalExecutive Officer, as required bySection 302 of the Sarbanes-Oxley Actof 2002 Included herewith     31.2 Certification of the PrincipalFinancial Officer, as required bySection 302 of the Sarbanes-Oxley Actof 2002 Included herewith     32.1 Certification of the PrincipalExecutive Officer pursuant to 18U.S.C. Section 1350, as adoptedpursuant to Section 906 of theSarbanes-Oxley Act of 2002 Included herewith     32.2 Certification of the PrincipalFinancial Officer pursuant to 18U.S.C. Section 1350, as adoptedpursuant to Section 906 of theSarbanes-Oxley Act of 2002 Included herewith