UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-K

|(Mark One)                                                        |                                                                                         
|----------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                                 | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934    
|For the fiscal year ended December 31, 2007                      
|OR                                                               
|o                                                                 | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|For the transition period
from:                                to

Commission File Number: 000-23267

DEPOMED, INC.(Exact Name of Registrant as Specified in its Charter)

|California(State or other jurisdiction of
incorporation or organization)           |  | 94-3229046(I.R.S. Employer Identification No.)
|---------------------------------------------------------------------------------- |  | ----------------------------------------------
|1360 O'Brien Drive, Menlo Park, California(Address of principal executive offices) |  | 94025(Zip Code)                               

Registrant's telephone number, including area code:(650) 462-5900

Securities
registered pursuant to Section 12(b) of the Act: Common Stock, no par value

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

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer, as defined in
Rule 12b-2 of the Exchange Act.

|Large accelerated filer o |  | Accelerated filer ý |  | Non-accelerated filer o (Do not check if a smaller reporting company) |  | Smaller reporting company o
|------------------------- |  | ------------------- |  | --------------------------------------------------------------------- |  | ---------------------------

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant based upon the closing price
of Common Stock on the Nasdaq Stock Market on June 30, 2007 was approximately $218,230,000. Shares of Common Stock held by each officer and director and by each person who owned 10% or more of
the outstanding Common Stock as of June 30, 2007 have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive
determination for other purposes.

The
number of shares outstanding of the registrant's Common Stock, no par value, as of March 6, 2008 was 47,866,571.

Documents Incorporated by Reference

Portions of the registrant's Proxy Statement, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with
the registrant's 2008 Annual Meeting of Shareholders, expected to be held on or about May 23, 2008, are incorporated by reference in Part III of this Form 10-K.



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DEPOMED, INC.    2007 FORM 10-K REPORT    TABLE OF CONTENTS

|         |  |                                                                                                                  |  | PAGE
|-------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|         |  | PART I                                                                                                           |  |     
|Item 1.  |  | Business                                                                                                         |  | 4   
|Item 1A. |  | Risk Factors                                                                                                     |  | 26  
|Item 1B. |  | Unresolved Staff Comments                                                                                        |  | 38  
|Item 2.  |  | Properties                                                                                                       |  | 38  
|Item 3.  |  | Legal Proceedings                                                                                                |  | 39  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                              |  | 39  
|         |  | PART II                                                                                                          |  |     
|Item 5.  |  | Market for the Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities |  | 42  
|Item 6.  |  | Selected Financial Data                                                                                          |  | 44  
|Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                            |  | 45  
|Item 7A. |  | Quantitative and Qualitative Disclosures about Market Risk                                                       |  | 59  
|Item 8.  |  | Financial Statements and Supplementary Data                                                                      |  | 59  
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                             |  | 59  
|Item 9A. |  | Controls and Procedures                                                                                          |  | 59  
|Item 9B. |  | Other Information                                                                                                |  | 62  
|         |  | PART III                                                                                                         |  |     
|Item 10. |  | Directors, Executive Officers and Corporate Governance                                                           |  | 62  
|Item 11. |  | Executive Compensation                                                                                           |  | 62  
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters                   |  | 62  
|Item 13. |  | Certain Relationships and Related Transactions, and Director's Independence                                      |  | 62  
|Item 14. |  | Principal Accountant Fees and Services                                                                           |  | 62  
|         |  | PART IV                                                                                                          |  |     
|Item 15. |  | Exhibits and Financial Statement Schedules                                                                       |  | 63  
|         |  | Signatures                                                                                                       |  | 67  

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NOTE REGARDING FORWARD-LOOKING STATEMENTS

Statements made in this Annual Report on Form 10-K that are not statements of historical fact are forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking
statements on our current expectations and projections about future events. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements.
Forward-looking statements are identified by words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may" and other similar expressions. In addition, any statements that refer to
expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements include, but are not necessarily limited to, those
relating to:



Factors
that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in the
"ITEM 1A. RISK FACTORS" section and elsewhere in this Annual Report on Form 10-K. We disclaim any intent to update or revise these
forward-looking statements to reflect new events or circumstances.

CORPORATE INFORMATION

The address of our Internet website ishttp://www.depomedinc.com. We make available, free of charge through our
website or upon written request, our Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and other periodic SEC reports, along with amendments to all of those reports, as soon as reasonably practicable
after we file the reports with the SEC.

Unless
the context indicates otherwise, "Depomed", "the Company", "we", "our" and "us" refer to Depomed, Inc. Depomed was incorporated in the State of California on
August 7, 1995. Our headquarters are located in Menlo Park, California.

Depomed®
and ProQuin® are registered trademarks of Depomed. Gabapentin GR and AcuForm are trademarks of Depomed. GLUMETZA®
is a registered trademark of Biovail Laboratories International, s.r.l. exclusively licensed in the United States to Depomed. All other trademarks and trade names referenced in this Annual
Report on Form 10-K are the property of their respective owners.

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PART I

ITEM 1.    BUSINESS

COMPANY OVERVIEW

Depomed is a specialty pharmaceutical company focused on the development and commercialization of differentiated products that address large and growing markets
and are based on proprietary oral drug delivery technologies. In 2004, we announced our determination to evolve from a solely product development focused company to an integrated specialty
pharmaceutical company, with sales and marketing of our own products. Preliminary staffing for these activities began in 2005. In 2006 and 2007, we enhanced our internal sales and marketing
capabilities through the hiring of additional sales and marketing employees and the engagement of consultants.

We
have developed two commercial products. GLUMETZA® (metformin hydrochloride extended release tablets) is a once-daily treatment for adults with type 2
diabetes that we commercialize in the United States. ProQuin® XR (ciprofloxacin hydrochloride extended release tablets) is a once-daily treatment for uncomplicated urinary
tract infections that we commercialize in the United States with Watson Pharma (Watson).

We
have a three-pronged approach to product development designed to optimize the use and value of our drug delivery technologies, while managing the costs and risks associated with
developing and commercializing pharmaceutical products. We develop products for our own account that are designed
to compete in large growing markets and that can be highly differentiated from immediate release versions of the compounds upon which they are based. Second, we selectively enter into collaborative
partnerships with other companies where the unique capabilities of our technology can provide superior value to a partner's compound, resulting in significantly greater value for Depomed than a
traditional fee-for-service arrangement. Third, we enter into arrangements that enable our technology to be applied by other companies to a greater number of compounds than our
infrastructure can support, so as to derive additional value from our technology. In the future, we plan to commercialize our proprietary products, relying on partners to cover the large primary care
audiences, while maintaining co-promotion and distribution rights in order to be in a position to create our own sales force when appropriate, thereby increasing the value to us of our
products, and our control over them.

Our
most advanced product candidate in development is Gabapentin GR, an extended release form of gabapentin. With respect to Gabapentin GR, we have completed a
Phase 2 clinical trial for the treatment of women with menopausal hot flashes. We have also completed a Phase 3 clinical trial for the treatment of postherpetic neuralgia, and have
initiated a second Phase 3 trial for the same indication. In addition, we have other product candidates in earlier stages of development, including a treatment for gastroesophageal reflux
disease.

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The
following table summarizes our marketed products, and our product pipeline.

|Marketed Products        
|-------------------------
|
|GLUMETZA®                
|ProQuin® XR              
|Product Pipeline         
|Gabapentin GR           
|                         
|                         
|Omeprazole               
|Undisclosed compound     
|Two undisclosed compounds

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SIGNIFICANT DEVELOPMENTS DURING 2007

Among the significant developments in our business during 2007 were the following:



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MARKETED PRODUCTS

GLUMETZA



The 500mg strength of GLUMETZA is our internally developed once-daily metformin product for type 2 diabetes. The FDA approved GLUMETZA for
marketing in the United States in June 2005. At

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that
time, a subsidiary of Biovail Corporation, or Biovail, held US and Canadian marketing rights to GLUMETZA pursuant to a license agreement we entered into with the Biovail subsidiary in 2002. We
reacquired the US rights to GLUMETZA from Biovail in December 2005. In June 2006, we entered into a promotion arrangement with King Pharmaceuticals (King) related to GLUMETZA under which we and King
jointly commercialize GLUMETZA in the United States. GLUMETZA was launched in the United States in September 2006. In February 2007, we obtained a waiver from the FDA of a Phase 4 pediatric
study on GLUMETZA.

In
October 2007, we terminated our promotion agreement with King related to GLUMETZA. Pursuant to the termination agreement, King paid us $29.7 million in termination and other
fees, and fulfilled its GLUMETZA promotion obligations through December 31, 2007. We are not required to pay King promotion fees on sales of GLUMETZA for periods after September 30,
2007. We are in discussions with potential marketing partners for GLUMETZA in the United States.

In
connection with the restructuring of our GLUMETZA agreements with Biovail in December 2005, we also acquired an exclusive US license to a 1000mg strength of GLUMETZA utilizing
proprietary Biovail drug delivery technology. In December 2007, the FDA approved the 1000mg formulation for marketing in the United States. We expect the 1000mg GLUMETZA to be available late in the
second quarter of 2008.

Our
issued US patents covering the 500mg GLUMETZA expire between 2016 and 2021. Biovail has a patent application related to the 1000mg formulation that is pending.

The
500mg GLUMETZA has also been approved for marketing in Canada, where it is marketed by Biovail, and in Korea, where it is marketed by LG Life Sciences under the trade name Novamet
GR.



Diabetes is a disease in which levels of glucose, a type of sugar found in the blood, are above normal. Diabetic patients do not produce insulin, a hormone
produced in the pancreas, or do not properly use insulin, making it difficult for the body to convert food into energy. Type 2 diabetes is the most common form of diabetes, accounting for 90 to
95 percent of all diabetes cases, according to the National Institute of Diabetes and Digestive and Kidney Diseases of the National Institutes of Health, or the NIDDK.

The
body breaks down food into glucose, and delivers glucose to cells through the bloodstream. Cells use insulin to help process blood glucose into energy. In the case of type 2
diabetes, cells fail to use insulin properly or the pancreas cannot make as much insulin as the body requires. That causes the amount of glucose in the blood to increase, while starving cells of
energy. Over time, high blood glucose levels damage nerves and blood vessels, which can lead to complications such as heart disease, stroke, blindness, kidney disease, nerve problems, gum infections,
and amputation.



According to the American Diabetes Association (ADA), 24 million people in the United States have diabetes. Of those, 17.5 million are diagnosed.
The ADA estimates that the number of diagnosed diabetics in the United States is increasing by approximately one million per year. Among adults with diagnosed diabetes, 57 percent take oral
medication only, and 12 percent take both insulin and oral medication, according to the 2001-2003 National Health Interview Survey of the Centers for Disease Control and Prevention.
In 2006, the metformin market in the United States was approximately $1.4 billion in retail sales.

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We are currently seeking a commercialization partner for GLUMETZA in the United States.

Publicis Selling Solutions.In February 2008, we entered into a professional detailing services agreement with Publicis
Selling Services pursuant to which approximately 33 part-time Publicis sales representatives detail GLUMETZA to physicians. The term of the contract is six months.

King Pharmaceuticals.In June 2006, we entered into a promotion agreement with King Pharmaceuticals pursuant to which we
granted King the co-exclusive right to promote GLUMETZA in the United States. Under the agreement, King was required to promote GLUMETZA to physicians in the United States through its
sales force, to deliver a minimum number of annual detail calls to potential GLUMETZA prescribers, and to maintain a sales force of a minimum size. In consideration for its promotion of GLUMETZA, King
received a promotion fee equal to fifty percent of gross margin, which was defined in the agreement as sales of GLUMETZA, net of returns, discounts, rebates and chargebacks, minus cost of goods sold
and certain adjustments. Out-of-pocket marketing expenses were shared with King at an agreed-upon ratio, in which Depomed's share was lower than King's.

In
October 2007, we and King terminated the promotion agreement. Pursuant to the termination agreement, King paid us $29.7 million in termination and other fees, and fulfilled its
GLUMETZA promotion obligations through December 31, 2007. We are not required to pay King promotion fees on sales of GLUMETZA for periods after September 30, 2007.

Biovail.We licensed US and Canadian rights to GLUMETZA to Biovail in 2002. In 2005, we received a $25.0 million
license fee payment from Biovail under our original license agreement following FDA approval of GLUMETZA. In December 2005, we and Biovail entered into an Amended and Restated License Agreement
relating to GLUMETZA. The Amended and Restated License Agreement supersedes our April 27, 2004 Amended License and Development Agreement with Biovail.

Pursuant
to the amended and restated license agreement, Biovail has an exclusive license in Canada to manufacture and market the 500mg GLUMETZA, and we receive royalties of six percent
of Canadian net sales of the 500mg GLUMETZA. We also receive payments from Biovail equal to one percent of Canadian net sales of the 1000mg GLUMETZA. The royalty payable by Biovail on net sales of the
500mg GLUMETZA was increased to ten percent for the period from June 30, 2007 to December 28, 2007, and returned to six percent when we obtained regulatory approval in the United States
of the 1000mg formulation of GLUMETZA.

In
December 2005, we also entered into a Manufacturing Transfer Agreement and a Supply Agreement with Biovail related to the 1000mg GLUMETZA with Biovail. Under those agreements, we
received an exclusive license to market the 1000mg GLUMETZA in the United States, and an exclusive license to the "GLUMETZA" trademark in the United States for the purpose of marketing GLUMETZA. We
will purchase 1000mg GLUMETZA exclusively from Biovail under the Supply Agreement, subject to back-up manufacturing rights in our favor. If we exercise our back-up
manufacturing rights, compensation to Biovail will change from a supply-based arrangement to royalties of six percent of net sales of the 1000mg GLUMETZA in the United States (or, if less, thirty
percent of royalties and other similar payments from our licensees) under the Manufacturing Transfer Agreement. Also, we will pay Biovail royalties of one percent of net sales of the 500mg GLUMETZA in
the United States (or, if less, five percent of royalties and other similar payments from our licensees).

LG Life Sciences.In August 2004, we entered into a license and distribution agreement granting LG Life Sciences an exclusive
license to the 500mg GLUMETZA in the Republic of Korea. LG Life Sciences launched the product, known as Novamet GR, in Korea in 2006.

We
received a $0.6 million upfront license fee from LG in connection with entering into the agreement. In November 2006, we amended the agreement to provide for a
$0.5 million milestone

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payment
from LG with respect to LG's approval to market GLUMETZA in the Republic of Korea, rather than a $0.7 million payment, as reflected in the original agreement. We received the
$0.5 million payment in November 2006, net of applicable Korean withholding taxes, and commenced negotiations to further amend the agreement to formally grant LG a license to manufacture the
500mg GLUMETZA in exchange for royalties on net sales of GLUMETZA in Korea, and to remove the provisions of the original agreement providing for the supply of 500mg GLUMETZA tablets by us to LG. In
January 2007, we completed our negotiations with LG, and entered into an amended license agreement implementing the provisions.

ProQuin® XR



ProQuin XR is a once-daily formulation of the antibiotic ciprofloxacin for uncomplicated urinary tract infections. We developed ProQuin XR, and the
FDA approved it for marketing in the United States in May 2005. Esprit Pharma licensed marketing rights to ProQuin XR in the United States in July 2005, and launched the product in the United States
in November 2005.

Our
issued US patents covering ProQuin XR expire between 2016 and 2020. We have additional US patent applications covering ProQuin XR that are pending.



A urinary tract infection, or UTI, is an infection in the urinary bladder. An uncomplicated UTI is a UTI that does not spread from the bladder to the kidney or
the prostate. Common symptoms associated with UTIs include a frequent urge to urinate and a painful, burning feeling in the area of the bladder or urethra during urination, and an overall
ill-feeling of malaise.

Uncomplicated
UTIs are very common in women between 20 and 50. The NIDDK reports that infections of the urinary tract are the second most common type of infection in the body, account
for approximately 8.3 million doctor visits each year, with one woman in five developing a UTI during her lifetime. According to the NIDDK, nearly 20% of women who experience a UTI will
experience another. 30% of women who experience a second UTI will have a third UTI, and 80% of women who have at least three UTIs, or approximately one woman in one hundred, will have recurrences.



Ciprofloxacin is a member of the family of drug compounds known as quinolones, which also includes levaquin. In 2006, there were approximately 8 million
prescriptions for quinolones filled in the United States.



Watson Pharma.In July 2007, following the termination of our ProQuin XR licensing arrangement with Esprit Pharma described
below, we entered into a promotion agreement with Watson Pharma, a subsidiary of Watson Pharmaceuticals, granting Watson a co-exclusive right to promote ProQuin XR to the urology specialty
and long-term care facilities in the United States. In September 2007, we amended the agreement to also grant Watson a co-exclusive right to promote ProQuin XR to the ob/gyn
specialty. Watson is required to deliver a minimum number of annual sales detail calls and maintain a sales force of a minimum size. Watson will receive a promotion fee equal to an agreed upon portion
of gross margin attributable to the urology and ob/gyn specialties and long-term care facilities above an agreed upon baseline level. We are responsible for the manufacture and
distribution of ProQuin XR. Each party bears all of its own personnel and other costs, including marketing expenses. The term of the promotion agreement is three years, subject to early termination in
certain

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circumstances,
with up to two additional one-year renewal periods at the election of Watson. We have retained the right to promote ProQuin XR to physicians outside the urology and ob/gyn
specialties and long-term care markets, either directly or through third parties. We and Watson re-launched ProQuin XR in October 2007.

Esprit Pharma.In July 2005, we entered into an exclusive license and marketing agreement with Esprit Pharma, Inc.
pursuant to which we granted Esprit exclusive US marketing and distribution rights to ProQuin XR. The agreement obligated Esprit to pay us $50 million in license fees; $30 million, which
was paid in 2005, and two $10 million installments in July 2006 and in July 2007. The agreement also provided for royalty payments to us of 15 percent to 25 percent of ProQuin XR
net sales, based on escalating net sales, subject to minimum royalty obligations of $4.6 million in 2006, $5.0 million in 2007 and in subsequent years remains at $5.0 million,
subject to annual increases in the consumer price index beginning in 2008. We also had a supply agreement with Esprit under which we provided Esprit with commercial quantities of ProQuin XR.

In
July 2006, we amended the license agreement with Esprit to, among other matters, extend to December 2006 the due date on the $10 million license fee payment to Depomed that had
been due in July 2006, to credit royalties paid to us for sales made in the fourth quarter of 2005 of ProQuin XR against Esprit's $4.6 million minimum royalty obligation in 2006, and to
establish a joint marketing team to periodically review and discuss all aspects of the commercialization of ProQuin XR.

Also
in July 2006, we entered into a co-promotion agreement with Esprit in which we obtained co-promotion rights to market ProQuin XR that permitted us to promote
ProQuin XR in the United States to up to 40,000 physicians in exchange for an 18% promotion fee.

In
December 2006, we delivered a notice to Esprit regarding alleged breaches by Esprit of the license agreement. The alleged breaches related to Esprit's failure to make a
$10 million license fee payment due to the Company in December 2006, and to use commercially reasonable efforts to market ProQuin XR. In connection with the notice, we filed a demand for
binding arbitration. Subsequent to the delivery of the notice and demand for arbitration, Esprit paid us the $10 million license fee payment in December 2006 and we withdrew without prejudice
the notice and demand for arbitration. We also agreed to commence, in January 2007, discussions with Esprit toward a mutually agreeable, long-term restructuring of the license agreement.

In
July 2007, we entered into a termination and assignment agreement with Esprit terminating the exclusive license and marketing agreement, and the related supply and
co-promotion agreements. Upon entering into the termination and assignment agreement, the marketing and distribution rights in the United States for ProQuin XR were transferred back to us
and Esprit paid us $17.5 million, representing (i) a $10.0 million payment in respect of the final license payment that would have been due to us in July 2007 under the exclusive
license and marketing agreement; (ii) a $2.5 million payment in respect to a pro-rated portion minimum royalties for 2007; and (iii) a $5.0 million termination
fee. The termination and assignment agreement removed Esprit's future minimum royalty obligations to us. Under the termination and assignment agreement, Esprit remains responsible for all returns and
rebates associated with ProQuin XR product distributed by Esprit.

Madaus/Rottapharm.In November 2005, we entered into a distribution and supply agreement for ProQuin XR in Europe with a
privately owned specialty pharmaceutical company, Madaus S.r.l., who was acquired by Rottapharm in June 2007. Under the terms of the agreement, we granted an exclusive right to Madaus for the
commercialization of ProQuin XR in Europe and agreed to supply Madaus with commercial quantities of ProQuin XR tablets in bulk form. In March 2006, Madaus filed a Marketing Authorization Application
for ProQuin XR with the Medical Products Agency in Sweden. We assisted Madaus with a response to comments and questions on the Marketing Authorization Application that Madaus received in May 2007.
Madaus submitted its response to the Swedish Medical Products Agency's questions and comments in August 2007, and submitted responses to further

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questions
and comments in December 2007. We anticipate that the Medical Products Agency will make a final determination on the application before the end of the second quarter of 2008.

PRODUCT CANDIDATES

Gabapentin GR for Neuropathic Pain



Gabapentin GR is our internally developed, extended release formulation of the compound gabapentin. Gabapentin is marketed by Pfizer Inc. for adjunctive
therapy for epileptic seizures and postherpetic pain under the trade name Neurontin. It is also marketed by a number of other companies as a generic, immediate release drug.

Postherpetic Neuralgia.Postherpetic neuralgia, or PHN, is a persistent pain condition caused by nerve damage during a
shingles, or herpes zoster, viral infection. There are an estimated 600,000 to 1 million cases of shingles each year, according to the Centers for Disease Control and Prevention. The incidence
of PHN increases in elderly shingles patients, in whom the incidence of PHN in shingles patients 50 to 69 years old is 50 percent and increases to 75 percent in patients over
70 years old, according to WWMR, Inc., a pharmaceutical market research firm. Pain associated with PHN reportedly can be so severe that patients are unable to resume normal activities
for months. Since there is no cure for PHN, treatments are focused on relieving pain.

Our
issued US patents covering Gabapentin GR for PHN expire between 2016 and 2021. We have a number of patent applications related to Gabapentin GR pending.

Diabetic Peripheral Neuropathy.Diabetic peripheral neuropathy, or DPN, is a peripheral nerve disorder caused by diabetes.
Approximately 60 to 70 percent of the more than 20 million diabetics in the United States have mild to severe forms of nervous system damage, according to the National Institutes of
Health. After a period of inadequate glycemic control, nerve damage may occur and may lead to a number of health problems, including indigestion, diarrhea or constipation, dizziness, bladder
infections and impotence. DPN is often associated with numbness, pain, or tingling in the feet or legs and may lead to weakness in the muscles of the feet. Current treatment approaches for DPN involve
providing options for pain relief and implementing glycemic control measures, including diet, exercise and medication, to prevent further tissue damage by bringing blood sugar levels under control.

Our
issued US patents covering Gabapentin GR for DPN expire between 2016 and 2021. We have a number of patent applications related to Gabapentin GR pending.



Approximately 2.6 million people are estimated to have suffered from moderate to severe neuropathic pain in 2004. The overall neuropathic pain market is
expected to reach $5 billion in 2010, according to Datamonitor.



2008 Phase 3 Postherpetic Neuralgia Study.In March 2008, we initiated dosing of the first patient in a Phase 3
clinical trial for Gabapentin GR for PHN. The study is a randomized, double-blind, placebo-controlled study of approximately 450 PHN patients. Patients in the study are randomized into two treatment
arms: placebo, or 1800mg of Gabapentin GR dosed once daily.

The
primary objective of the study is to assess the efficacy of Gabapentin GR in reducing the pain associated with PHN, measured from baseline pain scores to the end of a
ten-week treatment period on the basis of the Likert pain scale. Secondary objectives include an assessment of changes from

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baseline
in sleep interference, and additional patient and clinician assessments of pain and quality of life.

The
primary differences in the ongoing study relative to the Phase 3 PHN study we concluded in 2007 are: (a) there is only one active treatment arm (1800 mg once daily)
rather than two; and (b) patients enrolled in the study must have "stable PHN disease" for at least six months, rather than three months, following healing of the shingles rash.

In
November 2007, we submitted to the FDA a protocol for a Phase 3 registration trial for Gabapentin GR to the FDA for a special protocol assessment, or SPA, pursuant to which we
requested that the FDA assess whether the protocol is adequate to meet the scientific and regulatory requirements necessary to support marketing approval of Gabapentin GR for PHN. The FDA did provide
us with
guidance and comments on our proposed protocol, but indicated that the protocol was not eligible for an SPA.

2006/2007 Postherpetic Neuralgia Study.In May 2006, we initiated a Phase 3 clinical trial for Gabapentin GR for the
treatment of PHN. The study was a randomized, double-blind, placebo-controlled study of approximately 400 PHN patients. The study was fully enrolled in early March 2007. Patients in the study were
randomized into three treatment arms: placebo, a total daily dose of 1800mg of Gabapentin GR dosed once daily, and a total daily dose of 1800mg of Gabapentin GR dosed twice daily.

The
primary objective of the study was to assess the efficacy of Gabapentin GR in reducing the pain associated with PHN, measured from baseline pain scores to the end of a
ten-week treatment period on the basis of the Likert pain scale. Secondary objectives include an assessment of changes from baseline in sleep interference, and additional patient and
clinician assessments of pain and quality of life.

In
July 2007, we announced the primary endpoint was not achieved with statistical significance for either active treatment regimen, as compared to placebo, over the ten-week
treatment period. The mean reductions in average daily pain scores from baseline to end of study were 1.83 (once-daily), 1.72 (twice-daily) and 1.43 (placebo). However, statistical
significance relative to placebo was achieved in each of the first seven weeks for the once-daily treatment arm and in each of the first four weeks for the twice-daily treatment arm.

The
secondary endpoints of sleep interference, Clinical Global Impression of Change (CGIC), a scale used by physicians for overall assessment of patient improvement, and Patient Global
Impression of Change (PGIC), a scale used by patients to report their overall assessment of change, were all statistically significant for the once-daily treatment compared to placebo over
the ten week study period. Sleep interference scores were reduced by 2.01 points with Gabapentin GR compared to -1.39 with placebo (p=0.014). Physicians reported that 48.0% of patients taking
Gabapentin once-daily were "very much improved" or "much improved" compared to 27.1% of the patients who received placebo (p<0.001), as measured by the CGIC. Similar results
were observed for the PGIC in the once-daily and placebo arms (p=0.009).

Phase 2 Postherpetic Neuralgia Study.We conducted a randomized, double-blind, placebo-controlled Phase 2 trial
of 158 PHN patients, and reported the results of the study in January 2006. Patients were randomized into three treatment groups for four weeks of treatment: placebo, an 1800mg total daily dose of
Gabapentin GR given once daily, and an 1800mg total daily dose of Gabapentin GR given twice daily. The primary objective of the study was to assess the relative efficacy of Gabapentin GR
once-daily, twice-daily, and placebo in reducing PHN patients' average daily pain scores from baseline to the end of a four-week treatment period on the basis of the Likert
pain scale, and 11-point numerical rating scale used to assess pain intensity. Secondary objectives included assessments of changes from baseline in sleep interference, and additional
patient and clinician assessments of pain.

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Reductions in average daily pain scores were statistically significant with twice-daily Gabapentin GR from week two to the end of treatment based on the Likert pain scale. Clinically
significant improvements in the score were observed with mean change from baseline to study end of -2.24 compared to -1.29 for placebo (p=0.014). The secondary endpoint of sleep interference was also
statistically significantly different, with sleep interference scores reduced by -2.28 with Gabapentin GR compared to -1.16 with placebo (p=0.006).

For
once-daily Gabapentin GR, there was an improvement in pain that did not reach statistical significance, with a reduction in mean daily pain score of -1.93 with Gabapentin
GR compared to -1.29 with placebo (p=0.089). Sleep Interference Scores were reduced by -1.94 compared to -1.16 with placebo (p=0.048).

There
were no serious adverse events associated with Gabapentin GR. The most common side effects observed were dizziness (22% in the once-daily arm, 11% in the twice-daily
arm, and 10% in the placebo arm), and somnolence (9% in the once-daily arm, 8% in the twice-daily arm, and 8% in the placebo arm).

Phase 2 Diabetic Peripheral Neuropathy Study.In December 2006, we reported results of a Phase 2 randomized,
double-blind, placebo-controlled study of Gabapentin GR that involved 147 patients with diabetic peripheral neuropathy. Patients in the study were randomized into one of three treatment groups:
placebo, 3000mg of Gabapentin GR dosed once daily, or 3000mg of Gabapentin GR dosed twice daily. The primary objective of the study was to assess the efficacy of Gabapentin GR in treating the pain
associated with DPN, as measured by the Likert pain scale. Secondary objectives include an assessment of changes from baseline in sleep interference, and additional patient and clinician assessments
of pain and quality of life.

Reductions
in average daily pain scores from baseline to the end of treatment based on the Likert pain scale were statistically significant with once-daily Gabapentin GR.
Clinically significant improvements in the pain score were observed with a mean change from baseline to study end of -2.45 compared to -1.26 for placebo (p=0.002). Although not statistically
significantly different for twice-daily Gabapentin GR, there was pain improvement with a reduction in mean daily pain score of -1.75 with Gabapentin GR compared to -1.26 with placebo (p=0.190).

The
assessment of "responders", defined as patients with at least a 50 percent reduction in pain at endpoint compared to baseline, showed that both Gabapentin GR arms reached
statistical significance. The proportion of responders was 35 percent for once-daily Gabapentin GR (p=0.001), 26 percent for twice-daily Gabapentin GR (p=0.015) and
8 percent for placebo.

Sleep
interference decreased with both once and twice-daily Gabapentin GR, with once-daily Gabapentin GR reaching statistical significance. In the once-daily arm,
Sleep Interference Scores were reduced by -2.70 compared to -1.65 with placebo (p=0.01).

There
were no serious adverse events associated with Gabapentin GR in the trial. The most common side effects observed were dizziness and somnolence, which are commonly associated with
gabapentin. The reported incidences were 17.0% and 12.8% for dizziness and somnolence respectively for once-daily Gabapentin GR and 12.2% and 4.1%, respectively for twice-daily Gabapentin
GR.



We are currently seeking a development and commercialization partner for Gabapentin GR for neuropathic pain.

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Gabapentin GR for Menopausal Hot Flashes



We plan to use our existing Gabapentin GR formulation to study its safety and efficacy in the treatment of hot flashes associated with menopause. We have an
exclusive sublicense from PharmaNova, under United States Patent No. 6,310,098, held by the University of Rochester, to develop and commercialize in the United States a product that contains
gabapentin as its active pharmaceutical ingredient, and is indicated for the treatment of menopausal hot flashes. We believe that Gabapentin GR is an excellent non-hormonal product
candidate for this indication, because our Phase 2 clinical study and numerous academic studies have demonstrated that gabapentin may be effective in treating hot flashes, and gabapentin has a
long history of use in other indications.

The
patent we have sublicensed expires in 2020. We have a number of patent applications related to Gabapentin GR pending.



A hot flash is a sudden flushing and sensation of heat caused by dilation of skin capillaries. Hot flashes are often associated with menopausal endocrine
imbalance. The occurrence and frequency of hot flashes are unpredictable. Symptoms often associated with hot flashes include sweating, irritability and frustration.

Hot
flashes can begin early in menopause and are most common during the first few years after menopause begins. There are over 40 million postmenopausal women more than
55 years old and about 2 million women enter menopause every year in the United States. Approximately 80% of those women suffer from hot flashes.



Currently, the leading prescription drug product for the treatment of hot flashes associated with menopause is hormone replacement therapy, or HRT, which involves
the administration of the hormone estrogen, either alone or in combination with the hormone progestin. In 2001, the HRT market represented more than $2 billion and in excess of
90 million prescriptions. In 2003, the Women's Health Initiative released the results of a clinical study that revealed an increased risk of blood clots, stroke, and breast cancer associated
with HRT. Subsequently, in 2003, the HRT market decreased by more
than $850 million and 34 million prescriptions relative to 2001. HRT prescriptions declined to 44 million prescriptions in 2006.

Existing
non-hormonal pharmaceutical alternatives to HRT for the treatment of hot flashes include off-label administration of anti-depressants. There
is also a considerable market for dietary and herbal supplements for the treatment of hot flashes, although we are not aware of any clinical study demonstrating the safety and efficacy of any such
treatment.



Phase 2 Study.In June 2007, we randomized the first patient in a Phase 2 double-blind, placebo-controlled,
multi-center trial evaluating Gabapentin GR for the treatment of women with moderate-to-severe menopausal hot flashes. The 124 patient study was fully enrolled in September
2007.

Study Design.The study included 124 menopausal women (approximately 30 per group) with recurrent, moderate to severe hot
flashes and was conducted at eight sites in the United States. The total study treatment duration after screening and baseline was 13 weeks. The primary objective of the study was to
investigate the relationship between blood plasma concentrations of gabapentin observed

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in
menopausal women after administration of Gabapentin GR and the frequency of hot flashes in those women. The plasma concentration data (pharmacokinetics) and the hot flash frequency and severity
data (pharmacodynamics) will be used to construct a PK/PD dose response model designed to identify the dosing regimen to utilize in a Phase 3 program. The dose response model is expected to be
presented to the FDA at an end of Phase 2 meeting in 2008.

In
order to facilitate the generation of an optimal dose response model, patients in each of the three active treatment arms remained on a stable Gabapentin GR dose for five weeks at an
initial dose, followed by five weeks on a stable, incrementally higher dose, as follows.

Treatment Group

Weeks 2-6

Weeks 8-12A ("1800mg group")

600mg PM

600mg AM + 1200mg PMB ("2400mg group")

600mg AM + 600mg PM

600mg AM + 1800mg PMC ("3000mg group")

1200mg PM

1200mg AM + 1800mg PMD ("placebo group")

placebo

placebo


Each
stable dosing regimen was preceded by a one-week titration period

Efficacy.Gabapentin GR demonstrated a reduction in the mean frequency of moderate to severe hot flashes, and in the mean
severity of hot flashes, in all active treatment groups, with statistical significance relative to placebo from baseline to the end of the study observed in the 1800mg and 2400mg treatment groups. The
severity of hot flashes is based on a mean daily composite score, where the a moderate hot flash is assigned a score of "2" and a severe hot flash is assigned a score of "3". The primary efficacy
outcomes observed in the study are set forth in the table below.

Mean Daily Frequency (#)

Mean Daily Severity ScoreTreatment GroupBaseline

End of treatment

Baseline

End of treatment1800mg

10.1

2.7 (p=0.016)

24.0

6.9 (p=0.044)2400mg

11.6

3.0 (p=0.03)

29.6

6.8 (p=0.041)3000mg

11.4

3.9 (p=0.229)

27.8

10.1 (p=0.426)placebo

10.6

5.1

26.7

12.2


Safety.Gabapentin GR was generally well tolerated in the study, with one, two, one and three patients, respectively,
withdrawing due to adverse events from the placebo, 1800mg, 2400mg and 3000mg groups. The most common side effects observed in the study were headache, somnolence, dizziness and nausea. The incidence
of those side effects in each of the treatment groups is set forth in the table below.

Treatment
Group

Somnolence (%)

Dizziness (%)

Headache (%)

Nausea (%)1800mg

16

10

32

162400mg

16

39

32

33000mg

16

9

25

3placebo

3

10

10

7




PharmaNova.In October 2006, we entered into a sublicense agreement with PharmaNova, Inc. Pursuant to the agreement,
PharmaNova has granted us an exclusive sublicense, under United States Patent No. 6,310,098, held by the University of Rochester, to develop and commercialize in the United States a product
that contains gabapentin as its active pharmaceutical ingredient, and is indicated for the treatment of hot flashes associated with menopause.

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We paid PharmaNova an upfront license fee of $0.5 million upon signing of the agreement and are required to pay PharmaNova an additional $0.5 million upon dosing of the
first patient in any Phase 3 trial for the product, $1.0 million upon submission to the FDA of a New Drug Application, or NDA, for the product, and $2.0 million upon FDA approval
of an NDA. The agreement provides for royalty payments to PharmaNova on net sales of the product, and for milestone payments upon achievement of annual net sales in excess of certain thresholds. We
also paid PharmaNova consultancy fees of $0.3 million over approximately ten months beginning in November 2006.

Other.We are currently seeking a development and commercialization partner for Gabapentin GR for menopausal hot flashes.

Gastroesophageal Reflux Disease Program



Gastroesophageal reflux disease, or GERD, is a disorder of the digestive system caused by the failure of the lower esophageal sphincter muscle, or LES, to close
properly, which permits stomach contents to leak back into the esophagus. When stomach contents pass through the LES into the esophagus, stomach acid causes the burning sensation in the chest or
throat known as heartburn. Heartburn that occurs more than twice a week may be GERD. Other symptoms of GERD can include acid indigestion, bad breath, chest pain, hoarseness in the morning, and trouble
swallowing. According to the NIDDK, 20% of the US population suffers from GERD.



Treatments for GERD include: antacids designed to neutralize stomach acid, such as Alka-Seltzer, Mylanta and Rolaids, among others; foaming agents,
such as Gaviscon, that cover stomach contents with foam in order to prevent reflux; H2 blockers, such as cimetidine (Tagamet HB), famotidine (Pepcid AC) and ranitidine (Zantac), among
others; proton pump inhibitors, or PPIs, such as omeprazole (Prilosec), lansoprazole (Prevacid), and esomperzole (Nexium), among others; and drugs known as prokinetics that are designed to strengthen
the LES and accelerate stomach emptying. GERD treatments are often taken in combination.

The
US market for GERD treatments was in excess of $13 billion in 2006, according to IMS Health, Inc., a pharmaceutical market research firm.



In 2006, we conducted a Phase 1 GERD study designed to provide us with insight into our formulation strategy for our GERD program. We have also conducted
two proof-of-concept studies related to our GERD program. In the initial study, we determined that our gastric retentive omeprazole tablet can predictably deliver omeprazole
approximately four hours after ingestion.

In
August 2007, we announced the results of the second study. The Phase 2a pharmacokinetic/pharmacodynamic proof-of-concept study demonstrated the
potential clinical advantages of the delivery of omeprazole in two evening pulses to patients suffering with nocturnal acid breakthrough, or NAB, associated with GERD.

The
objective of the study was to determine if the delivery of a dose of omeprazole with dinner and a second dose four hours after dinner would reduce the incidence of NAB, which
typically occurs in the late evening and early morning hours. The study was an open label crossover study that involved 16 patients with at least three months history of GERD with recurrent nighttime
acid reflux while taking omeprazole or any other proton pump inhibitor. Fourteen of the 16 patients completed each of two treatment arms. In the proof-of-concept arm of the
study, patients received 20 mg of omeprazole with dinner followed by a second 20 mg dose four hours later, in order to simulate a two pulse delivery

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mechanism.
In the comparative arm of the study, patients received 40 mg of omeprazole 30 minutes before dinner.

Five
patients who received the two pulses of omeprazole did not have clinically meaningful blood levels of the drug associated with the first pulse and therefore did not provide useful
data for this trial, because the study objective was to evaluate a two pulse delivery of the drug. These patients received the commercially available formulation of omeprazole known as
Prilosec®. It is not known why these patients did not achieve blood levels with Prilosec.

In
the nine patients who did achieve blood levels from both doses of omeprazole, and thus provided useful data for the two pulse concept tested in the trial, none experienced NAB. In the
40 mg single dose treatment arm, three patients experienced NAB. All three of these patients had blood levels of omeprazole fall to undetectable levels between 2 a.m. and 3 a.m. Results
from both arms of the study therefore demonstrate the need to maintain adequate blood levels of omeprazole in order to inhibit NAB.

OTHER RESEARCH AND DEVELOPMENT AND COLLABORATIVE PROGRAMS

Supernus.In September 2006, we entered into a collaboration agreement with Supernus Pharmaceuticals, Inc. to develop
through a Phase 1 study a product candidate leveraging our AcuForm drug delivery technology. The cost and ownership of the program will be shared between the parties equally. The collaboration
agreement includes provisions pursuant to which the parties may negotiate and enter into a definitive agreement for the further development and for commercialization, by either or both parties, of the
product candidate. We expect the feasibility phase of the collaboration to be completed in the second quarter of 2008.

Biovail.In February 2007, we entered into a license and development agreement with Biovail granting Biovail an option to
license our AcuForm drug delivery technology to develop and commercialize up to
two pharmaceutical products. Pursuant to the agreement, Biovail paid us an upfront fee of $0.5 million in February 2007, and is contingently obligated to pay us additional fees related to the
exercise of the license option, the initiation of the first Phase 3 trial for each product and upon receipt of U.S. regulatory approval for each product. The agreement also stipulates that
Biovail make royalty payments to us on net commercial sales of any product developed under the agreement. Biovail has not yet exercised its option.

Also
in February 2007, we amended our stock purchase agreement with Biovail, which was originally entered into in May 2002. The amended stock purchase agreement removed Biovail's
observer rights on the Company's board of directors and removed the right of first negotiation in favor of Biovail with respect to any acquisition transactions of the Company.

Patheon.In August 2006, we entered into a collaboration agreement with Patheon, Inc., or Patheon, related to our
proprietary AcuForm drug delivery technology. Under the agreement, we have granted Patheon access to our AcuForm drug delivery technology for the purpose of formulating, developing and improving
pharmaceutical products outside of our own internal programs for Patheon's clients and collaborative partners. A joint committee with representatives from Depomed and Patheon reviews compounds prior
to initiating work to ensure there are no conflicts with our own internal programs. Patheon assumes primary responsibility for initial feasibility work with technical assistance from us. For product
candidates that advance beyond feasibility, Depomed, Patheon and any third party will negotiate a license agreement, and Depomed and Patheon would share any license fees, milestone payments and
royalties.

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RESEARCH AND DEVELOPMENT EXPENSES

Our research and development expenses were $23.3 million in 2007, $26.9 million in 2006, and $18.4 million in 2005.

OUR DRUG DELIVERY TECHNOLOGIES

The AcuForm technology is based on our proprietary oral drug delivery technologies and is designed to include formulations of drug-containing
polymeric tablets that allow multi-hour delivery of an incorporated drug. Although our formulations are proprietary, the polymers utilized in the AcuForm technology are commonly used in
the food and drug industries
and are included in the list of inert substances approved by the FDA for use in oral pharmaceuticals. By using different formulations of the polymers, we believe that the AcuForm technology is able to
provide continuous, controlled delivery of drugs of varying molecular complexity and solubility. With the use of different polymers and polymers of varying molecular weight, our AcuForm tablet
technology can deliver drugs by diffusion, tablet erosion, or from a bi-layer matrix. In addition, our technology allows for the delivery of more than one drug from a single tablet. If
taken with a meal, these polymeric tablets remain in the stomach for an extended period of time to provide continuous, controlled delivery of an incorporated drug.

The
AcuForm technology's design is based in part on principles of human gastric emptying and gastrointestinal transit. Following a meal, liquids and small particles flow continuously
from the stomach into the intestine, leaving behind the larger undigested particles until the digestive process is complete. As a result, drugs in liquid or dissolved form or those consisting of small
particles tend to empty rapidly from the stomach and continue into the small intestine and on into the large intestine, often before the drug has time to act locally or to be absorbed in the stomach
and/or upper small intestine. The drug-containing polymeric tablets of the AcuForm technology are formulated into easily swallowed shapes and are designed to swell upon ingestion. The
tablets attain a size after ingestion sufficient to be retained in the stomach for multiple hours during the digestive process while delivering the drug content at a controlled rate. After drug
delivery is complete, the polymeric tablet dissolves and becomes a watery gel, which is safely eliminated through the intestine sight unseen.

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The
following graphic demonstrates the operation of the AcuForm technology.

GRAPHIC

The
AcuForm technology is designed to address certain limitations of drug delivery and to provide for orally-administered, conveniently-dosed, cost-effective drug therapy
that provides continuous, controlled-delivery of a drug over a multi-hour period. We believe that the AcuForm technology can provide one or more of the following advantages over
conventional methods of drug administration:



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COMPETITION

GLUMETZA.GLUMETZA competes against immediate release metformin, which is marketed primarily by generic manufacturers.
GLUMETZA also competes against both branded and generic extended-release versions of metformin, such as Bristol-Myers Squibb's Glucophage XR and Sciele Pharma's Fortamet. Generic extended-release
metformin manufacturers include Barr Pharmaceuticals, Inc., ANDRX Corporation, Mylan Laboratories, Inc. and Teva Pharmaceutical Industries, Ltd., among others.

GLUMETZA
also competes against oral type 2 diabetes medications other than metformin, such as Takeda's Actos (pioglitazone hydrochloride), GlaxoSmithKline's Avandia
(risiglitazon), Pfizer's Glucotrol (sulfonylurea) and Merck's Januvia (sitagliptin), among others.

ProQuin XR.ProQuin XR competes against Cipro XR, a once-daily ciprofloxacin product for the treatment of urinary
tract infections that is marketed by Schering-Plough Corporation. ProQuin XR also competes against immediate release ciprofloxacin, which is marketed primarily by generic manufacturers. Generic Cipro
XR entered the market in 2007.

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Gabapentin GR for Neuropathic Pain.Gabapentin is currently marketed by Pfizer as Neurontin and by several generic
manufacturers for adjunctive therapy for epileptic seizures and for postherpetic pain. In addition, Pfizer has developed a new product, Lyrica (pregabalin), which has been approved for
marketing in the United States and the European Union for the treatment of postherpetic neuralgia, diabetic neuropathy, partial seizures and fibromyalgia.

If
approved, Gabapentin GR will compete against other neuropathic pain treatments, such as anti-depressants, other anti-convulsants, local anesthetics used as
regional nerve blockers, anti-arrythmics and opiods. We are also aware of at least one company that is developing a prodrug of gabapentin for the neuropathic pain market. To our knowledge,
we are the only company currently in clinical trials with a sustained release formulation of gabapentin for the United States market.

Gabapentin GR for Menopausal Hot Flashes.If approved, Gabapentin GR for hot flashes will compete against HRT, such as Wyeth
Pharmaceuticals' Premarin (estrogens) and Prempro (a combination of estrogens and a progestin) products, and anti-depressant medications prescribed off-label. Wyeth's
anti-depressant drug candidate, Pristiq, is in pre-registration for treatment of hot flashes. We are aware that Pfizer has non-exclusively licensed from the
University of Rochester rights to develop a hot flash product containing pregablin under the same patent we have sublicensed exclusive rights to develop a menopausal hot flash product containing
gabapentin. Accordingly, Pfizer may develop a competing hot flash product.

GERD.Any GERD product we develop will compete against the antacids, foaming agents, H2 blockers, proton pump
inhibitors and prokinetics described above under "GERD Treatments; Target Market".

Drug Delivery Technologies.Other companies that have oral drug delivery technologies competitive with the AcuForm technology
include Bristol-Myers Squibb, IVAX Corporation, ALZA Corporation (a subsidiary of Johnson & Johnson), SkyePharma plc, Biovail Corporation, Flamel Technologies S.A., Ranbaxy
Laboratories, Ltd., Kos Pharmaceuticals, Inc., Intec Pharma and Alpharma, Inc., all of which develop oral tablet products designed to release the incorporated drugs over time.
Each of these companies has patented technologies with attributes different from ours, and in some cases with different sites of delivery to the gastrointestinal tract.

General.We believe that we compete favorably in the markets described above on the basis of the safety and efficacy of our
products and product candidates, and, in some cases, on the basis of the price of our products. However, competition in pharmaceutical products and drug delivery technologies is intense, and we expect
competition to increase. There may be other companies developing products competitive with ours of which we are unaware. Competing product or technologies developed in the future may prove superior to
our products or technologies, either generally or in particular market segments. These developments could make our products or technologies noncompetitive or obsolete.

Most
of our principal competitors have substantially greater financial, sales, marketing, personnel and research and development resources than we do. In addition, many of our potential
collaborative partners have devoted, and continue to devote, significant resources to the development of their own products and drug delivery technologies.

PATENTS AND PROPRIETARY RIGHTS

Our success will depend in part on our ability to obtain and maintain patent protection for our technologies and to preserve our trade secrets. Our policy is to
seek to protect our proprietary rights, by among other methods, filing patent applications in the United States and foreign jurisdictions to cover certain aspects of our technology. We currently hold
nine issued United States patents, and have eighteen patent applications pending in the United States. In addition, we have prepared and continue to prepare patent applications relating to our
expanding technology for filing in the United States and

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abroad.
We have also applied for patents in numerous foreign countries. Some of those countries have granted our applications and other applications are still pending. Our pending patent applications
may lack priority over others' applications or may not result in the issuance of patents. Even if issued, our patents may not be sufficiently broad to provide protection against competitors with
similar technologies and may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products or may not provide us with competitive
advantages against competing products. We also rely on trade secrets and proprietary know-how, which are difficult to protect. We seek to protect such information, in part, through
entering into confidentiality agreements with employees, consultants, collaborative partners and others before such persons or entities have access to our proprietary trade secrets and
know-how. These confidentiality agreements may not be effective in certain cases, due to, among other things, the lack of an adequate remedy for breach of an agreement or a finding that an
agreement is unenforceable. In addition, our trade secrets may otherwise become known or be independently developed by competitors.

Our
ability to develop our technologies and to make commercial sales of products using our technologies also depends on not infringing others' patents or other intellectual property
rights. We are not aware of any intellectual property claims against us. However, the pharmaceutical industry has experienced extensive litigation regarding patents and other intellectual property
rights. For example,
Pfizer has initiated several suits against companies marketing generic gabapentin products, claiming that these products infringe Pfizer's patents. The results of this litigation could adversely
impact the commercialization of pharmaceutical products that contain gabapentin as an active pharmaceutical ingredient. Also, we are aware that patents issued to third parties relating to extended
release drug formulations or particular pharmaceutical compounds could in the future be asserted against us, although we believe that we do not infringe any valid claim of any patents. If claims
concerning any of our products were to arise and it was determined that these products infringe a third party's proprietary rights, we could be subject to substantial damages for past infringement or
be forced to stop or delay our activities with respect to any infringing product, unless we can obtain a license, or we may have to redesign our product so that it does not infringe upon others'
patent rights, which may not be possible or could require substantial funds or time. Such a license may not be available on acceptable terms, or at all. Even if we, our collaborators or our licensors
were able to obtain a license, the rights may be nonexclusive, which would give our competitors access to the same intellectual property. In addition, any public announcements related to litigation or
interference proceedings initiated or threatened against us, even if such claims are without merit, could cause our stock price to decline.

From
time to time, we may become aware of activities by third parties that may infringe our patents. Infringement by others of our patents may reduce our market shares (if a related
product is approved) and, consequently, our potential future revenues and adversely affect our patent rights if we do not take appropriate enforcement action. We may need to engage in litigation in
the future to enforce any patents issued or licensed to us or to determine the scope and validity of third-party proprietary rights. Our issued or licensed patents may not be held valid by a court of
competent jurisdiction. Whether or not the outcome of litigation is favorable to us, defending a lawsuit takes significant time, may be expensive and may divert management attention from other
business concerns. We may also be required to participate in interference proceedings declared by the United States Patent and Trademark Office for the purpose of determining the priority of
inventions in connection with our patent applications or other parties' patent applications. Adverse determinations in litigation or interference proceedings could require us to seek licenses which
may not be available on commercially reasonable terms, or at all, or subject us to significant liabilities to third parties. If we need but cannot obtain a license, we may be prevented from marketing
the affected product.

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MANUFACTURING

We have established internal manufacturing facilities that are in compliance with current good manufacturing practices, to manufacture supplies for our
Phase 1 and Phase 2 clinical trials.

We
are responsible for the supply and distribution of GLUMETZA. In December 2006, we entered into a manufacturing agreement with MOVA Pharmaceuticals related to the 500mg GLUMETZA. We
have two qualified suppliers for the active pharmaceutical ingredient in GLUMETZA. However, we obtain the active pharmaceutical ingredient to GLUMETZA on a purchase order basis only. We expect the
1000mg formulation of GLUMETZA to be available in the third quarter of 2008 and will rely on Biovail as our sole supplier.

We
are also responsible for the supply and distribution of ProQuin XR in the United States, and we will be responsible for supplying bulk ProQuin XR tablets to Rottapharm upon any
approval in Europe. For the manufacture of ProQuin XR tablets, we have entered into an agreement with MOVA Pharmaceuticals, as our sole supplier. Uquifa Mexico, S.A., our supplier of the active
pharmaceutical ingredient to ProQuin XR, is also a sole supplier to us. We obtain the active pharmaceutical ingredient to ProQuin XR on a purchase order basis only.

We
have obtained active pharmaceutical ingredient and clinical batches of Gabapentin GR from contract manufacturers on a purchase order basis. We currently have no long-term
supply arrangement with respect to Gabapentin GR.

We
also obtain polyethylene oxide, one of the excipients common to GLUMETZA, ProQuin XR and Gabapentin GR, on a purchase order basis from Dow Chemical, a sole source for polyethylene
oxide. We currently have no long-term supply arrangement with respect to polyethylene oxide.

Applicable
current Good Manufacturing Practices (cGMP) requirements and other rules and regulations prescribed by foreign regulatory authorities will apply to the manufacture of products
using the AcuForm technology. We will depend on the manufacturers of products using the AcuForm technology to comply with cGMP and applicable foreign standards. Any failure by a manufacturer of
products using the AcuForm technology to maintain cGMP or comply with applicable foreign standards could delay or prevent the initial or continued commercial sale of our products.

MARKETING AND SALES

In 2004, we announced our determination to evolve from a solely product development focused company to an integrated specialty pharmaceutical company, with sales
and marketing of our own products. Preliminary staffing for these activities began in 2005. In 2006 and 2007, we enhanced our internal sales and marketing capabilities through the hiring of additional
sales and marketing employees and the engagement of consultants. We anticipate the build-up of our commercial infrastructure will continue over the next several years.

In
2007, our commercial organization implemented distribution arrangements for ProQuin XR, developed and oversaw the re-launch of ProQuin XR in October 2007, transitioned to
us the GLUMETZA marketing efforts undertaken by King, and is involved in all aspects of the
commercialization of GLUMETZA and ProQuin XR. Our sales and marketing personnel are also engaged in preparation for the eventual commercialization of Gabapentin GR, and commercial and marketing
assessments of existing and potential product candidates.

All
marketing activities associated with GLUMETZA and ProQuin XR, as well as marketing activities related to any other products for which we obtain regulatory approval, will be subject
to numerous federal and state laws governing the marketing and promotion of pharmaceutical products. The FDA regulates post-approval promotional labeling and advertising to ensure that
they conform with statutory and regulatory requirements. In addition to FDA restrictions, the marketing of

23

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prescription
drugs is subject to laws and regulations prohibiting fraud and abuse under government healthcare programs. For example, the federal healthcare program antikickback statute prohibits
giving things of value to induce the prescribing or purchase of products that are reimbursed by federal healthcare programs, such as Medicare and Medicaid. In addition, federal false claims laws
prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government. Under this law, the federal government in recent years has brought
claims against drug manufacturers alleging that certain marketing activities caused false claims for prescription drugs to be submitted to federal programs. Many states have similar statutes or
regulations, which apply to items and services reimbursed under Medicaid and other state programs, or, in some states, regardless of the payer. If we, or our collaborative partners, fail to comply
with applicable FDA regulations or other laws or regulations relating to the marketing of our products, we could be subject to criminal prosecution, civil penalties, seizure of products, injunction,
exclusion of our products from reimbursement under government programs, as well as other regulatory actions against our product candidates, our collaborative partners or us.

GOVERNMENT REGULATION

Numerous governmental authorities in the United States and other countries regulate our research and development activities and those of our collaborative
partners. Governmental approval is required of all potential pharmaceutical products using the AcuForm technology and the manufacture and marketing of products using the AcuForm technology prior to
the commercial use of those products. The regulatory process takes several years and requires substantial funds. If new products using the AcuForm technology do not receive the required regulatory
approvals or if such approvals are delayed, our business would be materially adversely affected. There can be no assurance that the requisite regulatory approvals will be obtained without lengthy
delays, if at all.

In
the United States, the FDA rigorously regulates pharmaceutical products, including any drugs using the AcuForm technology. If a company fails to comply with applicable requirements,
the FDA or the courts may impose sanctions. These sanctions may include civil penalties, criminal prosecution of the company or its officers and employees, injunctions, product seizure or detention,
product recalls and total or partial suspension of production. The FDA may withdraw approved applications or refuse to
approve pending new drug applications, premarket approval applications, or supplements to approved applications.

We
generally must conduct preclinical testing on laboratory animals of new pharmaceutical products prior to commencement of clinical studies involving human beings. These studies
evaluate the potential efficacy and safety of the product. We then submit the results of these studies to the FDA as part of an Investigational New Drug application, which must become effective before
beginning clinical testing in humans.

Typically,
human clinical evaluation involves a time-consuming and costly three-phase process:



The
FDA closely monitors the progress of each phase of clinical testing. The FDA may, at its discretion, re-evaluate, alter, suspend or terminate testing based upon the data
accumulated to that

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point
and the FDA's assessment of the risk/benefit ratio to patients. The FDA may also require additional clinical trials after approval, which are known as Phase 4 trials.

The
results of the preclinical and clinical testing are submitted to the FDA in the form of a New Drug Application, or NDA, for approval prior to commercialization. An NDA requires that
our products are compliant with cGMP. Failure to achieve or maintain cGMP standards for products using the AcuForm
technology would adversely impact their marketability. In responding to an NDA, the FDA may grant marketing approval, request additional information or deny the application. Failure to receive
approval for any products using the AcuForm technology would have a material adverse effect on the Company.

The
FDA regulates not only prescription and over-the-counter drugs approved by NDAs, but also over-the-counter products that comply with
monographs issued by the FDA. These regulations include:



In
addition, the FDA may inspect over-the-counter products and manufacturing facilities. A failure to comply with applicable regulatory requirements may lead to
administrative or judicially imposed penalties. If an over-the-counter product differs from the terms of a monograph, it will, in most cases, require FDA approval of an NDA for
the product to be marketed.

Foreign
regulatory approval of a product must also be obtained prior to marketing the product internationally. Foreign approval procedures vary from country to country. The time required
for approval may delay or prevent marketing in certain countries. In certain instances we or our collaborative partners may seek approval to market and sell certain products outside of the United
States before submitting an application for United States approval to the FDA. The clinical testing requirements and the time required to obtain foreign regulatory approvals may differ from that
required for FDA approval. Although there is now a centralized European Union (EU) approval mechanism in place, each EU country may nonetheless impose its own procedures and requirements. Many of
these procedures and requirements are time-consuming and expensive. Some EU countries require price approval as part of the regulatory process. These constraints can cause substantial
delays in obtaining required approval from both the FDA and foreign regulatory authorities
after the relevant applications are filed, and approval in any single country may not meaningfully indicate that another country will approve the product.

EMPLOYEES

As of December 31, 2007, we had 73 full-time employees. None of our employees is represented by a collective bargaining agreement, nor have we
experienced any work stoppage. We believe that our relations with our employees are good.

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ITEM 1A.    RISK FACTORS

In addition to other information in this report, the following factors should be considered carefully in evaluating an investment in our securities. If any of the
risks or uncertainties described in this Form 10-K actually occurs, our business, results of operations or financial condition could be materially adversely affected. The risks and
uncertainties described in this Form 10-K are not the only ones facing us. Additional risks and uncertainties of which we are unaware or currently deem immaterial may also become
important factors that may harm our business.

Our recent Phase 3 trial for Gabapentin GR failed to meet the primary efficacy endpoint and there can be no assurance this product will be approved.

In July 2007, we announced that our drug candidate Gabapentin GR failed to meet the primary efficacy endpoint in a Phase 3 trial for postherpetic neuralgia
(PHN). We expect that at least one additional clinical trial will be required to obtain marketing approval in the United States for the product for the PHN indication. We are pursuing discussions with
potential development and marketing partners related to the continued development of Gabapentin GR for PHN. However, we may not secure a development and marketing arrangement on terms favorable to us,
or at all. In that event, we must consider conducting any required additional clinical trials alone.

We
submitted to the FDA a protocol for a Phase 3 registration trial for Gabapentin GR to the FDA for a special protocol assessment, or SPA, pursuant to which we requested that the
FDA assess whether the protocol is adequate to meet the scientific and regulatory requirements necessary to support marketing approval of Gabapentin GR for PHN. The FDA did provide us with guidance
and comments on our proposed protocol, but indicated that the protocol was not eligible for an SPA. Accordingly, there can be no assurance that the FDA will approve Gabapentin GR for PHN for marketing
even if we meet the primary endpoint in our current Phase 3 trial.

We
will incur significant additional expenses and will not know for at least one to two years whether the drug is safe and effective such that it could be approved for marketing. Even if
these trials are
successful, the approval date for the drug will not for at least two years, which means that we will not receive revenue from drug sales for a number of years, if at all.

We are engaged in litigation with respect to some of our intellectual property; if the outcome is adverse to the Company, it could materially affect our business.

In January 2006, we filed a complaint against IVAX Corporation in federal court for infringement of two of our U.S. patents related to the AcuForm delivery
technology. The complaint alleges infringement of our patents by IVAX's extended release metformin hydrochloride tablet. The trial in this case is currently scheduled for April 2008. Although we
intend to vigorously enforce our intellectual property rights, there can be no assurance that we will be successful in our litigation against IVAX. If one or more of our patents is declared
unenforceable, invalid or key claims are disallowed, the patent protection for our products and product candidates could be substantially weakened and our business and business prospects could be
severely impacted.

In
January 2008, Biovail filed a lawsuit against Apotex, Inc. in Canada related to Apotex's filing of the Canadian equivalent of an Abbreviated New Drug Application in Canada
seeking approval to market a generic version of the 500mg formulation of GLUMETZA in Canada. Apotex's regulatory filing alleges that certain of the Canadian patents that we have licensed to Biovail in
connection with Biovail's commercialization of GLUMETZA in Canada are invalid and unenforceable, and that Apotex's formulation does not infringe our patents. We have been joined to the lawsuit as a
co-plaintiff with Biovail because we are the licensor of the patents at issue in the suit. If one or more of our patents is declared invalid or key claims are disallowed, our Canadian
intellectual property could be substantially weakened.

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We have terminated our promotion arrangement with King Pharmaceuticals related to GLUMETZA in the United States, and have not yet identified a new commercialization partner for
the product.

In June 2006, we entered into a promotion agreement with King Pharmaceuticals pursuant to which King promoted GLUMETZA in the United States through its sales
force. In October 2007, following a strategic shift in focus by King toward its neuroscience and hospital/acute care business, we and King terminated the promotion agreement. Pursuant to the
termination of the promotion agreement, we received payments from King of approximately $29.7 million, and King will continue detailing GLUMETZA through December 31, 2007.

We
are seeking a new marketing partner for GLUMETZA. However, we have not yet identified a new marketing partner and we may not succeed in entering into a marketing arrangement for
GLUMETZA on favorable terms, or at all. We have not yet established a sales force, or contracted with a third party to act as our sales force, and we do not have immediate plans to do so. Accordingly,
the success of GLUMETZA will depend in large part on our ability to identify and enter into a marketing arrangement with a new partner. Even if we enter into a new marketing arrangement for GLUMETZA,
it may not be successful. Any failure to successfully commercialize GLUMETZA could have a material adverse effect on our business, financial conditions, results of operations and cash flows.

We have limited in-house sales and marketing resources, which we will require in order to successfully co-promote GLUMETZA and ProQuin XR through our
own sales force.

Although we have engaged a contract sales organization to promote GLUMETZA on a temporary basis, and we have the right to promote ProQuin XR through our own sales
force, or through third parties, we have no sales force and limited marketing and sales staff. The success of our own promotion efforts for GLUMETZA, ProQuin XR and any other product candidates that
receive regulatory approval that we choose to market or co-market will require that we substantially enhance our in-house marketing and sales force with technical expertise, or
make arrangements with third parties to perform these services for us. The development of the infrastructure associated with these activities involves substantial resources, and considerable attention
of our management and key personnel. To the extent that we enter into marketing and sales arrangements with other companies, our revenues will depend on the efforts of others. These efforts may not be
successful. If we fail to fully develop marketing and sales capabilities, or enter into arrangements with third parties, our revenues may suffer.

We depend on Watson Pharmaceuticals for the successful commercialization of ProQuin XR in the United States.

In July 2007, we granted Watson Pharmaceuticals co-exclusive marketing rights to ProQuin XR in the United States for the urology specialty and
long-term care sales channels. In September 2007, we expanded our promotion arrangement with Watson to include the ob/gyn specialty as well. As described above, we do not have a permanent
commercial sales force and do not, for the foreseeable future, expect to have the resources to successfully promote ProQuin XR on our own. Accordingly, we will depend on Watson to successfully promote
this drug. Our prior marketing partner for ProQuin XR, Esprit Pharma, was unable to successfully commercialize ProQuin XR following its initial launch in November 2005. As a result, we and Esprit
agreed to terminate the license in July 2007. It is possible that Watson could also have similar difficulties commercializing ProQuin XR. If Watson fails to successfully commercialize ProQuin XR, our
business, financial condition and results of operations may be materially and adversely affected.

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We are responsible for the distribution of GLUMETZA and ProQuin XR, and we have limited experience with distribution of pharmaceutical products.

We are responsible for the distribution of GLUMETZA and ProQuin XR in the United States. Our in-house commercial operations and distribution
capabilities are limited. In addition, we have entered into distribution arrangements with third parties, including Cardinal Health, AmeriSource Bergen and McKesson, and we will depend on them to
ensure that our marketed products are widely available. To continue to support our commercialization effort related to our marketed products, we must continue to enhance our internal commercial
infrastructure, and continue to contract with capable third parties to assist us in our commercialization efforts. The continued development of that infrastructure will also require substantial
resources, which may divert the attention of our management and key personnel. The efforts of third parties with whom we contract for distribution of our products may not be successful. Any failure on
our part to successfully develop distribution capabilities could cause delays in product sales and incur increased costs.

We depend on our marketing partners for the successful commercialization of GLUMETZA in Canada and Korea, and of ProQuin XR in Europe.

We have licensed exclusive marketing rights to the 500mg GLUMETZA in Canada to Biovail, and in Korea to LG Life Sciences. Biovail launched the 500mg GLUMETZA in
Canada in November 2005, and LG launched a 500mg product in Korea in 2006 under the trade name Novamet GR. We have also entered into a supply and distribution agreement with Madaus, a company acquired
by Rottapharm in June 2007, related to the commercialization of ProQuin XR in Europe. If our international commercial partners fail to successfully commercialize products we have licensed to them, our
business and future revenues may be adversely affected.

The development of drug candidates is inherently uncertain and we cannot be certain that any of our product candidates will be approved for marketing or, if approved, will
achieve market acceptance.

We have the following programs in clinical development: Gabapentin GR for postherpetic neuralgia, Gabapentin GR for diabetic peripheral neuropathy, Gabapentin GR
for menopausal hot flashes and omeprazole for gastroesophageal reflux disease. We also have other product candidates in earlier stages of development.

Our
own product candidates and those of our collaborative partners are subject to the risk that any or all of them may be found to be ineffective or unsafe, or otherwise may fail to
receive necessary regulatory clearances. Additionally, clinical trial results in earlier trials may not be indicative of results that will be obtained in subsequent larger trials, as was the case with
the Phase 3 trial for Gabapentin GR for the treatment of postherpetic neuralgia that we completed in 2007.

We
are unable to predict whether any of these product candidates will receive regulatory clearances or be successfully manufactured or marketed. Further, due to the extended testing and
regulatory review process required before marketing clearance can be obtained, the time frames for commercialization of any products are long and uncertain. Even if these other product candidates
receive regulatory clearance, our products may not achieve or maintain market acceptance. Also, substantially all of our product candidates use the AcuForm technology. If it is discovered that the
AcuForm technology could have adverse effects or other characteristics that indicate it is unlikely to be effective as a delivery system for drugs or therapeutics, our product development efforts and
our business would be significantly harmed.

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Our existing resources may not be sufficient to fund our operations until such time as we may be able to generate sufficient revenues to support our operations.

Our
existing capital resources may not be sufficient to fund our operations until such time as we may be able to generate sufficient revenues to support our operations. We have limited
credit facilities and, except for our common stock purchase agreement with Azimuth, we have no other committed sources of capital. To the extent that our capital resources are insufficient to meet our
future capital requirements, we will have to raise additional funds through the sale of our equity securities or from development and licensing arrangements to continue our development programs. We
may be unable to raise such additional capital on favorable terms, or at all. If we raise additional capital by selling our equity or convertible debt securities, the issuance of such securities could
result in dilution of our shareholders' equity positions. If adequate funds are not available we may have to:



The
inability to raise additional capital could have a material adverse effect on our business.

We are expecting operating losses in the future.

To date, we have recorded limited revenues from license fees, product sales, royalties, collaborative research and development arrangements and feasibility
studies. For the years ended December 31, 2007, 2006 and 2005, we recorded total revenue of $65.6 million, $9.6 million, and $4.4 million, respectively. For the years ended
December 31, 2006 and 2005 we incurred net losses of $39.7 million, and $24.5 million, respectively. The termination of our license agreement with Esprit in July 2007, including
the accelerated recognition of previously deferred revenue under the arrangement, and termination fees received associated with the termination of our promotion agreement with King have resulted in
our reaching profitability in 2007. However, as we continue our research and development efforts, preclinical testing and clinical trial activities, we anticipate that we will incur operating losses
in fiscal year 2008. Therefore, we expect our cumulative losses to increase. These losses, among other things, have had, and we expect that they will continue to have, an adverse impact on our total
assets, shareholders' equity and working capital.

Our operating results may fluctuate and affect our stock price.

The following factors will affect our operating results and may result in a material adverse effect on our stock price:



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As
a result of these factors, our stock price may continue to be volatile and investors may be unable to sell their shares at a price equal to, or above, the price paid. Additionally,
any significant drops in our stock price, such as the one we experienced following the announcement of our Gabapentin GR Phase 3 trial results, could give rise to shareholder lawsuits, which
are costly and time consuming to defend against and which may adversely affect our ability to raise capital while the suits are pending, even if the suits are ultimately resolved our favor.

Our collaborative arrangements may give rise to disputes over commercial terms, contract interpretation and ownership of our intellectual property and may adversely affect the
commercial success of our products.

We currently have a have a collaboration agreement with Supernus, Inc. providing for the development of a product candidate through feasibility, with the
possibility to enter into a definitive agreement providing for the further development of the product candidate, by either or both parties. We also have a collaboration arrangement with
Patheon, Inc. related to the potential development of product candidates for third parties. In addition, we have in the past and may in the future enter into other collaborative arrangements,
some of which have been based on less definitive agreements, such as memoranda of understanding, material transfer agreements, options or feasibility agreements. We may not execute definitive
agreements formalizing these arrangements. Collaborative relationships are generally complex and may give rise to disputes regarding the relative rights, obligations and revenues of the parties,
including the ownership of intellectual property and associated rights and obligations, especially when the applicable collaborative provisions have not been fully negotiated and documented. Such
disputes can delay collaborative research, development or commercialization of potential products, and can lead to lengthy, expensive litigation or arbitration. The terms of collaborative arrangements
may also limit or preclude us from developing products or technologies developed pursuant to such collaborations. Additionally, the collaborators under these arrangements might breach the terms of
their respective agreements or fail to prevent infringement of the licensed patents by third parties. Moreover, negotiating collaborative arrangements often takes considerably longer to conclude than
the parties initially anticipate, which could cause us to enter into less favorable agreement terms that delay or defer recovery of our development costs and reduce the funding available to support
key programs.

We
may be unable to enter into future collaborative arrangements on acceptable terms, which would harm our ability to develop and commercialize our current and potential future products.
Further, even if we do enter into collaboration arrangements, it is possible that our collaborative partners may not choose to develop and commercialize products using the AcuForm technology. Other

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factors
relating to collaborations that may adversely affect the commercial success of our products include:



Generally,
our collaborative arrangements do not restrict our collaborative partners from competing with us or restrict their ability to market or sell competitive products. Our current
and any future collaborative partners may pursue existing or other development-stage products or alternative technologies in preference to those being developed in collaboration with us. Our
collaborative partners may also terminate their collaborative relationships with us or otherwise decide not to proceed with development and commercialization of our products.

Our licensed patent covering the use of gabapentin to treat hot flashes associated with menopause is a method-of-use patent, which increases the risk
that prescriptions for gabapentin to treat hot flashes in menopausal women could be written for, or filled with, generic gabapentin.

We have an exclusive sublicense from PharmaNova, Inc. to a patent held by the University of Rochester to develop and commercialize in the United States a
gabapentin product for the treatment of hot flashes associated with menopause. Because a method-of-use patent, such as the patent we have sublicensed from PharmaNova, covers
only a specified use of a particular compound, not a particular composition of matter, we cannot prevent others from commercializing gabapentin. Accordingly, physicians could prescribe another
manufacturer's gabapentin to treat hot flashes in menopausal women rather than Gabapentin GR, or pharmacists could seek to fill prescriptions for Gabapentin GR with another manufacturer's gabapentin.
Although any such "off-label" use would violate our licensed patent, effectively monitoring compliance with our licensed patent may be difficult and costly.

It is difficult to develop a successful product. If we do not develop a successful product we may not be able to raise additional funds.

The drug development process is costly, time-consuming and subject to unpredictable delays and failures. Before we or others make commercial sales of
products using the AcuForm technology, other than GLUMETZA and ProQuin XR, we, our current and any future collaborative partners will need to:



We
will have to curtail, redirect or eliminate our product development programs if we or our collaborative partners find that:



Even
when or if our products obtain regulatory approval, successful commercialization requires:



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Any
material delay or failure in the governmental approval process and/or the successful commercialization of our potential products would adversely impact our financial position and
liquidity and would make it difficult for us to raise financing on favorable terms, if at all.

If we do not achieve our projected development and commercialization goals in the timeframes we announce and expect, the commercialization of our product candidates may be
delayed and our business will be harmed and our stock price may decline.

For planning purposes, we estimate the timing of the accomplishment of various scientific, clinical, regulatory and other product development and
commercialization goals. These milestones may include our expectations regarding the commercial launch of our products by us or our licensees, and the commencement or completion of scientific studies
and clinical trials and the submission of regulatory filings. From time to time, we may publicly announce the expected timing of some of these milestones, such as the completion of an ongoing clinical
trial, or the initiation of other clinical programs. All of these milestones are based on a variety of assumptions. The actual timing of these milestones can vary
considerably from our estimates depending on numerous factors, some of which are beyond our control, including:



If
we fail to achieve our announced milestones in the timeframes we announce and expect, our business and results of operations may be harmed and the price of our stock may decline.

We depend on clinical investigators and clinical sites to enroll patients in our clinical trials and other third parties to manage the trials and to perform related data
collection and analysis, and, as a result, we may face costs and delays outside of our control.

We rely on clinical investigators and clinical sites to enroll patients and other third parties to manage our trials and to perform related data collection and
analysis. However, we may be unable to control the amount and timing of resources that the clinical sites that conduct the clinical testing may devote to our clinical trials. If our clinical
investigators and clinical sites fail to enroll a sufficient number of patients in our clinical trials or fail to enroll them on our planned schedule, we will be unable to complete these trials or to
complete them as planned, which could delay or prevent us from obtaining regulatory approvals for our product candidates.

Our
agreements with clinical investigators and clinical sites for clinical testing and for trial management services place substantial responsibilities on these parties, which could
result in delays in,

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or
termination of, our clinical trials if these parties fail to perform as expected. For example, if any of our clinical trial sites fail to comply with FDA-approved good clinical
practices, we may be unable to use the data gathered at those sites. If these clinical investigators, clinical sites or other third parties do not carry out their contractual duties or obligations or
fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols or for other reasons, our
clinical trials may be extended, delayed or terminated, and we may be unable to obtain regulatory approval for, or successfully commercialize, our product candidates.

If we are unable to obtain or maintain regulatory approval, we will be limited in our ability to commercialize our products, and our business will be harmed.

The regulatory process is expensive and time consuming. Even after investing significant time and expenditures on clinical trials, we may not obtain regulatory
approval of our product candidates. Data obtained from clinical trials are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval, and the FDA may not agree
with our methods of clinical data analysis or our conclusions regarding safety and/or efficacy. Significant clinical trial delays would impair our ability to commercialize our products and could allow
our competitors to bring products to market before we do. In addition, changes in regulatory policy for product approval during the period of product development and regulatory agency review of each
submitted new application may cause delays or rejections. Even if we receive regulatory approval, this approval may entail limitations on the indicated uses for which we can market a product.

Further,
with respect to our approved products, once regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review. The discovery of previously
unknown problems with a product or manufacturer may result in restrictions on the product, manufacturer or manufacturing facility, including withdrawal of the product from the market. Manufacturers of
approved products are also subject to ongoing regulation, including compliance with FDA regulations governing current Good Manufacturing Practices (cGMP). Failure to comply with manufacturing
regulations can result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal of the government
to renew marketing applications and criminal prosecution.

Pharmaceutical marketing is subject to substantial regulation in the United States.

All marketing activities associated with ProQuin XR and GLUMETZA, as well as marketing activities related to any other products for which we obtain regulatory
approval, will be subject to numerous federal and state laws governing the marketing and promotion of pharmaceutical products. The FDA regulates post-approval promotional labeling and
advertising to ensure that they conform to statutory and regulatory requirements. In addition to FDA restrictions, the marketing of prescription drugs is subject to laws and regulations prohibiting
fraud and abuse under government healthcare programs. For example, the federal healthcare program antikickback statute prohibits giving things of value to induce the prescribing or purchase of
products that are reimbursed by federal healthcare programs, such as Medicare and Medicaid. In addition, federal false claims laws prohibit any person from knowingly presenting, or causing to be
presented, a false claim for payment to the federal government. Under this law, the federal government in recent years has brought claims against drug manufacturers alleging that certain marketing
activities caused false claims for prescription drugs to be submitted to federal programs. Many states have similar statutes or regulations, which apply to items and services reimbursed under Medicaid
and other state programs, or, in some states, regardless of the payer. If we, or our collaborative partners, fail to comply with applicable FDA regulations or other laws or regulations relating to the
marketing of our products, we could be subject to criminal prosecution, civil penalties, seizure of products, injunction, and exclusion of our products from reimbursement under

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government
programs, as well as other regulatory actions against our product candidates, our collaborative partners or us.

The approval process outside the United States is uncertain and may limit our ability to develop, manufacture and sell our products internationally.

To market any of our products outside of the United States, we and our collaborative partners, including Madaus, are subject to numerous and varying foreign
regulatory requirements, implemented by foreign health authorities, governing the design and conduct of human clinical trials and marketing approval for drug products. The approval procedure varies
among countries and can involve additional
testing, and the time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process includes all of the risks associated with obtaining FDA
approval set forth above, and approval by the FDA does not ensure approval by the health authorities of any other country, nor does the approval by foreign health authorities ensure approval by the
FDA.

If we or our marketing partners are unable to obtain acceptable prices or adequate reimbursement for our products from third-party payers, we will be unable to generate
significant revenues.

In both domestic and foreign markets, sales of our product candidates will depend in part on the availability of adequate reimbursement from third-party payers
such as:



If
reimbursement is not available for our products or product candidates, demand for these products may be limited. Further, any delay in receiving approval for reimbursement from
third-party payers would have an adverse effect on our future revenues. Third-party payers are increasingly challenging the price and cost-effectiveness of medical products and services.
Significant uncertainty exists as to the reimbursement status of newly approved healthcare products, including pharmaceuticals. Our products may not be considered cost effective, and adequate
third-party reimbursement may be unavailable to enable us to maintain price levels sufficient to realize an acceptable return on our investment.

Federal
and state governments in the United States and foreign governments continue to propose and pass new legislation designed to contain or reduce the cost of healthcare. Existing
regulations affecting pricing may also change before many of our product candidates are approved for marketing. Cost control initiatives could decrease the price that we receive for any product we may
develop.

We may be unable to compete successfully in the pharmaceutical product and drug delivery system industries.

Other companies that have oral drug delivery technologies competitive with the AcuForm technology include Bristol-Myers Squibb, IVAX Corporation (a subsidiary of
TEVA Pharmaceutical Industries, Ltd.), ALZA Corporation (a subsidiary of Johnson & Johnson), SkyePharma plc, Biovail Corporation, Flamel Technologies S.A., Ranbaxy
Laboratories, Ltd., Kos Pharmaceuticals, Inc., Intec Pharma and Alpharma, Inc., all of which develop oral tablet products designed to release the incorporated drugs over time.
Each of these companies has patented technologies with attributes different from ours, and in some cases with different sites of delivery to the gastrointestinal tract.

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Bristol-Myers Squibb is currently marketing a sustained release formulation of metformin, Glucophage XR, with which GLUMETZA competes. The limited license that Bristol-Myers Squibb
obtained from us under our November 2002 settlement agreement extends to certain current and internally-developed future compounds, which may increase the likelihood that we will face competition from
Bristol-Myers Squibb in the future on products in addition to GLUMETZA. Several other companies, including Barr Pharmaceuticals, Inc., Mylan Laboratories, Inc. and Teva Pharmaceutical
Industries, Ltd. have received FDA approval for and are selling a controlled-release metformin product.

Bayer
Corporation developed a once-daily ciprofloxacin product for the treatment of urinary tract infections, which is currently marketed by Schering-Plough Corporation.
There may be other companies developing products competitive with GLUMETZA and ProQuin XR of which we are unaware.

Gabapentin
is currently marketed by Pfizer as Neurontin for adjunctive therapy for epileptic seizures and for postherpetic pain. Pfizer's basic U.S. patents relating to Neurontin have
expired, and numerous companies have received approval to market generic versions of the immediate release product. In addition, Pfizer has developed a new product, Lyrica (pregabalin),
which has been approved for marketing in the U.S. and the European Union.

Competition
in pharmaceutical products and drug delivery systems is intense. We expect competition to increase. Competing technologies or products developed in the future may prove
superior to the AcuForm technology or products using the AcuForm technology, either generally or in particular market segments. These developments could make the AcuForm technology or products using
the AcuForm technology noncompetitive or obsolete.

Most
of our principal competitors have substantially greater financial, sales, marketing, personnel and research and development resources than we do. In addition, many of our potential
collaborative partners have devoted, and continue to devote, significant resources to the development of their own drug delivery systems and technologies.

We depend on third parties who are single source suppliers to manufacture ProQuin XR, GLUMETZA and our other product candidates. If these suppliers are unable to manufacture
ProQuin XR, GLUMETZA or our product candidates, our business will be harmed.

We are responsible for the supply and distribution of GLUMETZA, and MOVA Pharmaceuticals, a subsidiary of Patheon, Inc., is our sole supplier for tablets
of the 500mg strength of GLUMETZA pursuant to a supply agreement we entered into with MOVA Pharmaceuticals in December 2006. Biovail is our sole supplier for the 1000mg formulation GLUMETZA. We will
be unable to manufacture GLUMETZA in a timely manner if we are unable to obtain GLUMETZA 500mg tablets from our contract manufacturer, active pharmaceutical ingredient from suppliers, or excipient
suppliers, or GLUMETZA 1000mg tablets from Biovail.

We
are also responsible for supply and distribution of ProQuin XR. For the manufacture of ProQuin XR tablets, we have entered into an agreement with MOVA Pharmaceuticals, as our sole
supplier. We purchase the active ingredient for ProQuin XR from Uquifa Mexico, S.A., a sole supplier to us, on a purchase order basis. We will also be responsible for the manufacture of bulk
ProQuin XR tablets to Madaus for the European market, if the product is approved for marketing in European jurisdictions. We intend to purchase ProQuin XR tablets from MOVA Pharmaceuticals for that
purpose. If we are unable, for whatever reason, to obtain the active pharmaceutical ingredient or ProQuin XR tablets from our contract manufacturers, we may be unable to manufacture ProQuin XR in a
timely manner, if at all.

Although
we have obtained clinical batches of Gabapentin GR from a contract manufacturer, we currently have no long-term supply arrangement with respect to Gabapentin GR. Any
failure to obtain

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clinical
supplies of Gabapentin GR could adversely affect our Gabapentin GR clinical development programs.

We depend on third parties to manufacture our products, which could adversely affect our ability to deliver our products to market on a timely or competitive basis.

We do not have, and we do not intend to establish in the foreseeable future, internal commercial scale manufacturing capabilities. Rather, we intend to use the
facilities of third parties to manufacture products for Phase 3 clinical trials and commercialization. Our dependence on third parties for the manufacture of products using the AcuForm
technology may adversely affect our ability to deliver such products on a timely or competitive basis. The manufacturing processes of our third party manufacturers may be found to violate the
proprietary rights of others. If we are unable to contract for a sufficient supply of required products on acceptable terms, or if we encounter delays and difficulties
in our relationships with manufacturers, the market introduction and commercial sales of our products will be delayed, and our future revenue will suffer.

A successful product liability claim against us could materially harm our business.

Our business involves exposure to potential product liability risks that are inherent in the development and production of pharmaceutical products. We have
obtained product liability insurance for clinical trials currently underway and forecasted 2008 sales of our products, but:



Our
inability to obtain adequate insurance coverage at an acceptable cost could prevent or inhibit the commercialization of our products. Defending a lawsuit would be costly and
significantly divert management's attention from conducting our business. If third parties were to bring a successful product liability claim or series of claims against us for uninsured liabilities
or in excess of insured liability limits, our business, financial condition and results of operations could be materially harmed.

Our success is dependent in large part upon the continued services of our CEO and senior management with whom we do not have employment agreements.

Our success is dependent in large part upon the continued services of our President and Chief Executive Officer, Carl A. Pelzel, and other members of our
executive management team, and on our ability to attract and retain key management and operating personnel. We do not have agreements with Mr. Pelzel or any of our other executive officers that
provide for their continued employment with us. Our former Chairman, President and Chief Executive Officer retired in August 2007, and our Chief Financial Officer retired in October 2007. We may have
difficulty filling open senior scientific, financial and commercial positions. Management, scientific and operating personnel are in high demand in our industry and are often subject to competing
offers. The loss of the services of one or more members of management or key employees or the inability to hire additional personnel as needed could result in delays in the research, development and
commercialization of our products and potential product candidates.

36

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If we choose to acquire new and complementary businesses, products or technologies, we may be unable to complete these acquisitions or to successfully integrate them in a cost
effective and non-disruptive manner.

Our success depends on our ability to continually enhance and broaden our product offerings in response to changing customer demands, competitive pressures and
technologies. Accordingly, we may in the future pursue the acquisition of complementary businesses, products or technologies instead of developing them ourselves. We have no current commitments with
respect to any acquisition or such investment. We do not know if we would be able to successfully complete any acquisitions, or whether we would be able to successfully integrate any acquired
business, product or technology or retain any key employees. Integrating any business, product or technology we acquire could be expensive and time consuming, disrupt our ongoing business and distract
our management. If we were to be unable to integrate any acquired businesses, products or technologies effectively, our business would suffer. In addition, any amortization or charges resulting from
the costs of acquisitions could harm our operating results.

We have implemented certain anti-takeover provisions.

Certain provisions of our articles of incorporation and the California General Corporation Law could discourage a third party from acquiring, or make it more
difficult for a third party to acquire, control
of our company without approval of our board of directors. These provisions could also limit the price that certain investors might be willing to pay in the future for shares of our common stock.
Certain provisions allow the board of directors to authorize the issuance of preferred stock with rights superior to those of the common stock. We are also subject to the provisions of
Section 1203 of the California General Corporation Law which requires a fairness opinion to be provided to our shareholders in connection with their consideration of any proposed "interested
party" reorganization transaction.

We
have adopted a shareholder rights plan, commonly known as a "poison pill". The provisions described above, our poison pill and provisions of the California General Corporation Law may
discourage, delay or prevent a third party from acquiring us.

Increased costs associated with corporate governance compliance may significantly impact our results of operations.

Changing laws, regulations and standards relating to corporate governance, public disclosure and compliance practices, including the Sarbanes-Oxley Act of 2002,
new SEC regulations and NASDAQ Global Market rules, are creating uncertainty for companies such as ours in understanding and complying with these laws, regulations and standards. As a result of this
uncertainty and other factors, devoting the necessary resources to comply with evolving corporate governance and public disclosure standards has resulted in and may in the future result in increased
general and administrative expenses and a diversion of management time and attention to compliance activities. We also expect these developments to increase our legal compliance and financial
reporting costs. In addition, these developments may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced
coverage or incur substantially higher costs to obtain coverage. Moreover, we may be unable to comply with these new rules and regulations on a timely basis.

These
developments could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We are presently evaluating and
monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result. To the extent these costs are significant, our selling, general and
administrative expenses are likely to increase.

37

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If we sell shares of our common stock under our equity line of credit arrangement or in other future financings, existing common shareholders will experience immediate dilution
and, as a result, our stock price may go down.

We may from time to time issue additional shares of common stock at a discount from the current trading price of our common stock. As a result, our existing
common shareholders will experience immediate dilution upon the purchase of any shares of our common stock sold at such discount. For example, in December 2006, we entered into a common stock purchase
agreement with Azimuth Opportunity Ltd., pursuant to which we may sell shares of common stock at a discount to the prevailing market price ranging from approximately 3.8% to 6.4%, excluding an
additional placement agent fee of approximately 1.1% payable by us on the gross offering proceeds. In addition, as other capital raising opportunities present themselves, we may enter into financing
or similar arrangements in the future, including the issuance of debt securities, preferred stock or common stock. If we issue common stock or securities convertible into common stock, our common
shareholders will experience dilution and this dilution will be greater if we find it necessary to sell securities at a discount to prevailing market prices.

If we are unable to satisfy regulatory requirements relating to internal controls, our stock price could suffer.

Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to conduct a comprehensive evaluation of their internal control over financial reporting.
At the end of each fiscal year, we must perform an evaluation of our internal control over financial reporting, include in our annual report the results of the evaluation, and have our external
auditors publicly attest to such evaluation. If material weaknesses were found in our internal controls in the future, if we fail to complete future evaluations on time, or if our external auditors
cannot attest to our future evaluations, we could fail to meet our regulatory reporting requirements and be subject to regulatory scrutiny and a loss of public confidence in our internal controls,
which could have an adverse effect on our stock price.

Business interruptions could limit our ability to operate our business.

Our operations are vulnerable to damage or interruption from computer viruses, human error, natural disasters, telecommunications failures, intentional acts of
vandalism and similar events. In particular, our corporate headquarters are located in the San Francisco Bay area, which has a history of seismic activity. We have not established a formal disaster
recovery plan, and our back-up operations and our business interruption insurance may not be adequate to compensate us for losses that occur. A significant business interruption could
result in losses or damages incurred by us and require us to cease or curtail our operations.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.    PROPERTIES

We currently lease approximately 55,000 square feet of laboratory and office facilities in Menlo Park, California. The lease terms are through June 2009 with
options to extend the lease terms for an additional five years. We expect that these facilities will accommodate our growth for the next year. In March 2008, we subleased approximately 9,000
square feet of this space. The sublease term is through June 2009 with an option to extend the lease for an additional five years.

38

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ITEM 3.    LEGAL PROCEEDINGS

Depomed v. IVAX

We are involved in legal proceedings relating to some of our intellectual property rights. In January 2006, we filed a complaint against IVAX Corporation in the
U.S. District Court for the Northern District of California for infringement of U.S. Patent Nos. 6,340,475 and 6,635,280, both of which we own. The patents relate to our AcuForm delivery
technology. The complaint alleges infringement of our patents by IVAX's extended release metformin hydrochloride tablets. In April 2006, IVAX filed an answer and counterclaim, in which it alleged that
the patents in the suit are not infringed by IVAX and are invalid and unenforceable.

In
December 2006, the court issued an order construing certain of the claim terms appearing in the patents. Fact and expert discovery in the case is substantially complete. In September
2007, we submitted a motion for summary judgment of infringement. In October 2007, IVAX submitted motions for summary judgment of invalidity, inequitable conduct, lack of willfulness, and for
construction of a claim term appearing in the patents. A consolidated hearing on the parties' summary judgment motions was held on November 20, 2007.

In
December 2007, the court granted our motion for summary judgment of infringement, and denied all three of IVAX's summary judgment motions. The court also issued an order construing an
additional claim term appearing the patents.

The
trial for this matter is currently scheduled for April 14 - 17, 2008.

Biovail and Depomed v. Apotex (Canadian Generic GLUMETZA Litigation)

In December 2007, Apotex, Inc. ("Apotex") filed the Canadian equivalent of an Abbreviated New Drug Application in Canada seeking approval to market a
generic version of the 500mg formulation of GLUMETZA in Canada. Apotex's regulatory filing alleges that certain of the Canadian patents that we have licensed to Biovail in connection with Biovail's
commercialization of GLUMETZA in Canada are invalid and unenforceable, and that Apotex's formulation does not infringe our patents. Pursuant to our Canadian license agreement with Biovail for
GLUMETZA, Biovail has the first right to prosecute, and pay for expenses related to, any Canadian litigation related to generic challenges to GLUMETZA. In January 2008, Biovail filed suit against
Apotex in Canada in response to Apotex's regulatory filing, and we have been joined to the lawsuit as a co-plaintiff with Biovail because we are the licensor of the patents at issue in the
suit. The initiation of the lawsuit automatically stays approval of Apotex's formulation for 24 months. An adverse outcome in this matter could substantially weaken our Canadian intellectual
property.

General

We may from time to time become party to actions, claims, suits, investigations or proceedings arising from the ordinary course of our business, including actions
with respect to intellectual property claims, breach of contract claims, labor and employment claims, and other matters. Although actions, claims, suits, investigations and proceedings are inherently
uncertain and their results cannot be predicted with certainty, other than the matters set forth above, we are not currently involved in any matters that we believe may have a material adverse effect
on our business, financial position, results of operations or cash flow. However, regardless of the outcome, litigation can have an adverse impact on us because of associated cost and diversion of
management time.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2007.

39

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EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT

Our executive and other officers of the company and their ages as of December 31, 2007 are as follows:

|Name                  |  | Age |  | Position                                                         
|--------------------- |  | --- |  | -----------------------------------------------------------------
|Carl A. Pelzel        |  | 57  |  | President and Chief Executive Officer, Director                  
|Kera Alexander        |  | 51  |  | Vice President, Administration and Human Resources               
|Tammy L. Cameron      |  | 42  |  | Controller and Interim Principal Accounting and Financial Officer
|Matthew M. Gosling    |  | 37  |  | Vice President and General Counsel                               
|John N. Shell         |  | 54  |  | Vice President, Operations                                       
|Michael Sweeney, M.D. |  | 47  |  | Vice President, Product Development                              
|Thadd M. Vargas       |  | 42  |  | Vice President, Business Development                             

Carl A. Pelzeljoined Depomed in June 2005 as Vice President, Marketing and Commercial Development. He was appointed to the position of
Executive Vice President and Chief Operating Officer in September 2005, a position he held until being appointed President and Chief Executive Officer in August 2007. Mr. Pelzel was also
appointed the board of directors at that time. Before joining Depomed, Mr. Pelzel was Senior Vice President, Global Commercial Operations at Chiron Corporation from June 2003 to September 2004.
Prior to joining Chiron, Mr. Pelzel was President and Chief Executive Officer of Invenux Inc., a privately-held biopharmaceutical company from March 2001 to November 2002.
Mr. Pelzel also spent 11 years with GlaxoSmithKline in senior-level sales, marketing and international operational positions, including Country Manager of Hong Kong and China. He spent
13 years with American Home Products, focused primarily on their antibiotics business. During his career, he directed the launch of five major pharmaceutical products, many on a global basis.
Mr. Pelzel has a B.A. degree from Hartwick College of Oneonta, New York and a Masters degree in Natural Sciences from the University of Paris.

Kera Alexanderhas served as Vice President, Administration and Human Resources since October 2007, after having served as Senior
Director, Corporate Administration and Human Resources since March 2005. Ms. Alexander joined the Company in February 1997. Prior to joining Depomed, Ms. Alexander held various positions
at ALZA Corporation, including Manager, Shareholder Relations. Ms. Alexander received her Professional in Human Resources (PHR) certification in 2005.

Tammy L. Cameronhas served as Controller since July 2007. In October 2007, Ms. Cameron was named interim principal financial and
accounting officer. From January 2005 to June 2007, Ms. Cameron served as the Controller of Adeza Biomedical Corporation, a publicly-traded medical device company. From 2001 to 2005,
Ms. Cameron served as the Director of Finance and Administration of Timi3 Systems, a venture-backed medical device company. Prior to Timi3 Systems, Ms. Cameron served as Director of
Treasury and External Reporting of KeraVision, Inc., a publicly-traded medical device company and as a member of Ernst & Young's audit practice. She is a Certified Public Accountant and
holds a B.A. degree from California State University, East Bay.

Matthew M. Goslinghas served as Vice President and General Counsel since June 2006. Before joining Depomed, Mr. Gosling was a
partner at Heller Ehrman LLP, a national law firm, where he served a nine-year tenure as a corporate transactional attorney. Mr. Gosling received his law degree from the
University of Chicago and holds a B.A. degree from Trinity University, San Antonio, Texas.

John N. Shellhas served as Vice President, Manufacturing Technology since February 2008. Mr. Shell previously served as Vice
President of Operations since December 2006, and as Director of Operations for the Company from its inception in August 1995 until December 1996. From May 1994

40

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to
August 1995, Mr. Shell served in a similar capacity at the Depomed Division of M6. Mr. Shell served as a director of the company from its inception until November 2003. Prior to 1994,
Mr. Shell served as Materials Manager for Ebara International Corporation, a multi-national semiconductor equipment manufacturer, and as Materials Manager for ILC Technology, an electro-optics
and electronics manufacturer. Mr. Shell received his B.A. degree from the University of California, Berkeley.

Michael Sweeney, M.D.joined Depomed as Vice President of Product Development in December 2007. Before joining Depomed, Dr. Sweeney
was Vice President of Medical Affairs at CV Therapeutics from August 2003 to September 2007. Prior to CV Therapeutics, Dr. Sweeney spent 11 years at Pfizer Pharmaceuticals in New York
and the U.K. where he held a variety of senior-level medical and marketing positions, including Director of Marketing, Viagra Worldwide Team and Global Urology Medical Group Leader for Pfizer's
urological products Viagra, Cardura and Detrol. Prior to Pfizer, he served as a senior clinical pharmacologist and a medical advisor at Zeneca PLC. Dr. Sweeney received his M.D. degree
from Manchester University in the U.K. together with post graduate diplomas in Pharmaceutical Medicine and Pharmacoepidemiology, the latter from the University of London. He also is a Fellow of the
Royal College of Physicians of Edinburgh.

Thadd M. Vargashas served as the Company's Vice President of Business Development since December 2002. Before joining the company,
Mr. Vargas was Vice President of Finance at Worldres.com, Inc., Director of Finance at Kosan Biosciences, Inc. and Director of Business Development at Anergen, Inc. Prior
to Anergen, Mr. Vargas was a member of Ernst & Young's life sciences audit practice. Mr. Vargas holds a B.A. degree in Business Economics from the University of California at
Santa Barbara.

41

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PART II

ITEM 5.    MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock trades on the NASDAQ Global Market (NASDAQ) under the symbol "DEPO". The following table sets forth, for the periods indicated, the intraday high
and low prices of our common stock as reported by the NASDAQ from January 1, 2006 to December 31, 2007.

High

Low2006First Quarter

$
7.19

$
5.57Second Quarter

$
6.99

$
5.65Third Quarter

$
6.08

$
3.75Fourth Quarter

$
4.82

$
2.742007First Quarter

$
4.16

$
3.13Second Quarter

$
5.24

$
3.39Third Quarter

$
4.99

$
1.69Fourth Quarter

$
3.68

$
1.90


On
March 10, 2008, the closing price of our common stock was $2.82. As of March 6, 2008, there were approximately 60 shareholders of record of our common stock, one of
which is Cede & Co., a nominee for Depository Trust Company, or DTC. All of the shares of common stock held by brokerage firms, banks and other financial institutions as nominees for
beneficial owners are deposited into participant accounts at DTC, and are therefore considered to be held of record by Cede & Co. as one shareholder.

Dividends

We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings to finance the growth and development of
our business and therefore, do not anticipate paying any cash dividends in the foreseeable future.

42

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Stock Price Performance Graph

The following graph compares total shareholder returns of Depomed for the past five years to two indices: the NASDAQ Composite Index and the NASDAQ Biotechnology
Index. The total return for Depomed's common stock and for each index assumes the reinvestment of all dividends, although cash dividends have never been declared on Depomed's common stock.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*  Among Depomed, Inc., The NASDAQ Composite Index  And The NASDAQ Biotechnology Index

GRAPHIC

---

43

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ITEM 6.    SELECTED FINANCIAL DATA

|                                                          |                                                                                | Year Ended December 31, |  
|--------------------------------------------------------- | ------------------------------------------------------------------------------ | ----------------------- | -
|
|Consolidated Statement of Operations Data (in thousands): |                                                                                |                         |  
|                                                          | Total revenues                                                                 |                         | $
|                                                          | Total costs and expenses(1)                                                    |                         |  
|                                                          | Gain on termination of Esprit agreements                                       |                         |  
|                                                          | Gain on termination of King agreement                                          |                         |  
|                                                          | Income (loss) from operations(1)                                               |                         |  
|                                                          | Gain from extinguishment of debt                                               |                         |  
|                                                          | Net income (loss) before income taxes(1)                                       |                         |  
|                                                          | Provision for income taxes                                                     |                         |  
|                                                          | Net income (loss)(1)                                                           |                         |  
|                                                          | Deemed dividend on preferred stock                                             |                         |  
|                                                          | Net income (loss) applicable to common stock shareholders(1)                   |                         |  
|                                                          | Basic net income (loss) per share applicable to common stock shareholders(1)   |                         | $
|                                                          | Diluted net income (loss) per share applicable to common stock shareholders(1) |                         | $
|                                                          | Shares used in computing basic net income (loss) per share                     |                         |  
|                                                          | Shares used in computing diluted net income (loss) per share                   |                         |  
|
|
|Consolidated Balance Sheet Data                           |                                                                                |                         |  
|                                                          | Cash, cash equivalents and marketable securities                               |                         | $
|                                                          | Total assets                                                                   |                         |  
|                                                          | Deferred revenue, non-current portion                                          |                         |  
|                                                          | Long-term obligations, non-current portion                                     |                         |  
|                                                          | Series A convertible preferred stock                                           |                         |  
|                                                          | Accumulated deficit                                                            |                         |  
|                                                          | Total shareholders' equity (deficit)                                           |                         |  

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44

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ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Depomed is a specialty pharmaceutical company focused on the development and commercialization of differentiated products that address large and growing markets
and are based on proprietary oral drug delivery technologies. We have developed two commercial products. GLUMETZA® (metformin hydrochloride extended release tablets) is a
once-daily treatment for adults with type 2 diabetes. ProQuin® XR (ciprofloxacin hydrochloride extended release tablets) is a once-daily treatment for
uncomplicated urinary tract infections that we commercialize in the United States with Watson Pharma.

We
have a three-pronged approach to product development designed to optimize the use and value of our drug delivery technologies, while managing the costs and risks associated with
developing and commercializing pharmaceutical products. We develop products for our own account that are designed to compete in large growing markets and that can be highly differentiated from
immediate release versions of the compounds upon which they are based. Second, we selectively enter into collaborative partnerships with other companies where the unique capabilities of our technology
can provide superior value to a partner's compound, resulting in significantly greater value for Depomed than a traditional fee-for-service arrangement. Third, we enter into
arrangements that enable our technology to be applied by other companies to a greater number of compounds than our infrastructure can support, so as to derive additional value from our technology. In
the future, we plan to commercialize our proprietary products, relying on partners to cover the large primary care audiences, while maintaining co-promotion and distribution rights in
order to be in a position to create our own sales force when appropriate, thereby increasing the value to us of our products, and our control over them.

Our
most advanced product candidate in development is Gabapentin GR, an extended release form of gabapentin. With respect to Gabapentin GR, we have completed a
Phase 2 clinical trial for the treatment of women with menopausal hot flashes. We have also initiated a Phase 3 clinical trial for the treatment of postherpetic neuralgia. In addition,
we have other product candidates in earlier stages of development, including a treatment for gastroesophageal reflux disease.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

A detailed discussion of our significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements, and the impact and
risks associated with our accounting policies are discussed throughout this Annual Report on Form 10-K and in the footnotes to the consolidated financial statements. Critical
accounting policies are those that require significant judgment and/or estimates by management at the time that financial statements are prepared such that materially different results might have been
reported if other assumptions had been made. We consider certain accounting policies related to revenue recognition and use of estimates to be critical policies. These estimates form the basis for
making judgments about the carrying values of assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable
under the circumstances. Actual results could differ materially from these estimates.

We
believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions
and judgments about matters that are inherently uncertain.

45

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Revenue Recognition

We recognize revenue from the sale of our products, license fees and royalties earned on license agreements and collaborative arrangements. Revenue arrangements
with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is
objective and reliable evidence of the fair value of the undelivered items. The consideration received is allocated among the separate units based on their respective fair values, and the applicable
revenue recognition criteria are applied to each of the separate units. Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred and title has passed,
the price is fixed or determinable and we are reasonably assured of collecting the resulting receivable.

We
sell GLUMETZA and ProQuin XR product to wholesalers and retail pharmacies. We began selling GLUMETZA in September 2006, and we relaunched ProQuin XR in October 2007. Our returns
policy allows product returns within the period beginning six months prior to expiration and ending twelve months following product expiration. Given our limited history of selling GLUMETZA and
ProQuin XR, we currently cannot reliably estimate expected returns of the product at the time of shipment. Accordingly, we defer recognition of revenue on product shipments of GLUMETZA and ProQuin XR
until the right of return no longer exists, which occurs at the earlier of the time GLUMETZA and ProQuin XR units are dispensed through patient prescriptions or expiration of the right of return. We
estimate patient prescriptions dispensed using an analysis of third-party information, including third-party market research data and information obtained from wholesalers with respect to inventory
levels and inventory movement. We have not had significant history estimating the number of patient prescriptions dispensed. If we underestimate or overestimate patient prescriptions dispensed for a
given period, adjustments to revenue may be necessary in future periods. As a result of this policy, we recognized $12.5 million in product sales, which is net of wholesaler fees, prompt
payment discounts, patient support programs, chargebacks and Medicaid rebates for the year ended December 31, 2007. We have a deferred revenue balance of $6.5 million at
December 31, 2007 related to GLUMETZA and ProQuin XR product shipments that have not been recognized as revenue, which is net of wholesaler fees, prompt payment discounts, chargebacks and
Medicaid rebates. We will recognize revenue upon the earlier of prescription units dispensed or expiration of the right of return until we can reliably estimate product returns, at which time we will
record a one-time increase in net revenue related to the recognition of revenue previously deferred. In addition, the costs of manufacturing GLUMETZA and ProQuin XR associated with the
deferred revenue are recorded as deferred costs, which are included in inventory, until such time the deferred revenue is recognized.

Revenues
from product sales are recorded net of wholesaler fees, prompt payment discounts, patient support programs, chargebacks and Medicaid rebates. These
gross-to-net sales adjustments are recognized in the same period the related revenue is recognized and are based on estimates of the amounts earned or to be claimed on the
related sales. We believe our estimates related to gross-to-net sales adjustments for wholesaler fees, prompt payment discounts, patient support programs and chargebacks do not
have a high degree of estimation complexity or uncertainty as the related amounts are settled within a relatively short period of time. We do consider our estimates related to Medicaid rebates to be
more complex. However, they have historically not been material amounts. If Medicaid reimbursement for our products increases or we enter into new managed care contracts for our products, these
estimates may be material in future periods.

Revenue
from license arrangements, including license fees creditable against future royalty obligations (if any), of the licensee, is recognized when an arrangement is entered into if we
have substantially completed our obligations under the terms of the arrangement and our remaining involvement is inconsequential and perfunctory. If we have significant continuing involvement under
such an arrangement, license fees are deferred and recognized over the estimated performance period.

46

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License
fee payments received in excess of amounts earned are classified as deferred revenue until earned.

Research and Development Expense and Accruals

Research and development expenses include related salaries, clinical trial costs, consultant fees and allocations of corporate costs. All such costs are charged
to research and development expense as incurred. These expenses result from our independent research and development efforts as well as efforts associated with collaborations. Our expense accruals for
clinical trials are based on estimates of the services received from clinical trial centers and clinical research organizations. If possible, we obtain information regarding unbilled services directly
from service providers. However, we may be required to estimate these services based on information available to our product development or administrative staff. If we underestimate or overestimate
the activity associated with a study or service at a given point in time, adjustments to research and development expenses may be necessary in future periods. Historically, our estimated accrued
liabilities have approximated actual expense incurred.

Stock-Based Compensation

As of January 1, 2006, we began accounting for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123
(revised 2004),Share-Based Payment(FAS123(R)), using the modified prospective transition method. We use the Black-Scholes option valuation model to
estimate the fair value of stock options and Employee Stock Purchase Plan (ESPP) shares. The Black-Scholes model requires the input of highly subjective assumptions. The most significant assumptions
are our estimates of the expected volatility and the expected term of the award. For our volatility assumption, we use the historical volatility of our common stock over the expected term of the
options. We have concluded that our historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term and therefore, as of January 1, 2006, we
estimate the expected term of options granted by taking the average of the vesting term and the contractual term of the option, as illustrated in SEC Staff Accounting Bulletin No. 107
(SAB 107). As required, we review our valuation assumptions at each grant date and, as a result, we are likely to change our valuation assumptions used to value employee stock-based awards
granted in future periods. FAS 123(R) requires that employee and director stock-based compensation costs be recognized over the vesting period of the award, and we have elected to use the
straight-line attribution method.

Prior
to January 1, 2006, we measured compensation expense for our employee stock-based compensation plans using the intrinsic value method under APB No. 25. Under APB
No. 25, no stock-based compensation was recognized for the ESPP or for option grants when the exercise price of the options granted was equal to or greater than the fair value market price of
the stock on the grant date. In accordance with the provisions of FAS 123(R), we eliminated the balance of the deferred compensation calculated under APB No. 25 to the common stock
account on January 1, 2006.

FAS 123(R)
requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We
estimated forfeitures based on
historical experience. Prior to the adoption of FAS 123(R), pro forma information required under FAS 123 included forfeitures as they occurred.

47

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RESULTS OF OPERATIONS

Revenues

Total revenues are summarized in the following table (in thousands):

2007

2006

2005Product sales:GLUMETZA

$
12,489

$
526

$
ProQuin XR


13


1,265


930Total product sales


12,502


1,791


930Royalties:GLUMETZA


207


109


ProQuin XR


2,500


3,931


669Total royalties


2,707


4,040


669License revenue:GLUMETZA


2,359


1,542


151ProQuin XR


47,508


2,068


424AcuForm technology


500





Total license revenue


50,367


3,610


575Collaborative revenue


6


110


2,231Total revenues

$
65,582

$
9,551

$
4,405


Product sales

We began selling GLUMETZA to wholesalers and retail pharmacies in September 2006 and defer recognition of revenue on product shipments of GLUMETZA until the right
of return no longer exists, which occurs at the earlier of the time GLUMETZA units are dispensed through patient prescriptions or expiration of the right of return. At December 31, 2007, we
have a deferred revenue balance, which is classified as a liability on the consolidated balance sheet, of $6.1 million associated with the deferral of revenue on GLUMETZA product shipments,
which is net of estimated wholesaler fees, prompt
payment discounts, chargebacks and Medicaid rebates. In October 2007, we terminated our promotion agreement related to GLUMETZA with King and King's promotion obligations ended in December 2007. In
February 2008, we began detailing GLUMETZA through a contract sales organization, as we do not have an established sales organization. We expect product sales for GLUMETZA to increase in 2008,
however, this may be dependent on the success of our contract sales organization as well as the timing of, or the ability to find one or more commercialization partners for GLUMETZA.

ProQuin
XR product sales in 2006 and 2005 relate to our supply agreement with Esprit. We began supplying Esprit with commercial quantities of ProQuin XR in the fourth quarter of 2005. In
2007, there were no sales pursuant to the supply agreement. We terminated the license and supply agreements with Esprit in July 2007 and the marketing and distribution rights in the United States for
ProQuin XR reverted back to us.

In
October 2007, we re-launched ProQuin XR with Watson, and began selling to wholesalers and retail pharmacies. We defer recognition of revenue on product shipments of
ProQuin XR until the right of return no longer exists, which occurs at the earlier of the time ProQuin XR units are dispensed through patient prescriptions or expiration of the right of return. At
December 31, 2007, we have a deferred revenue balance, which is classified as a liability on the consolidated balance sheet, of $0.4 million associated with the deferral of revenue on
ProQuin XR product shipments, which is net of

48

---



estimated
wholesaler fees, stocking allowances, prompt payment discounts, chargebacks and Medicaid rebates. We expect product sales of ProQuin XR to increase in 2008.

Royalties

Our agreements with Esprit provided for royalty payments by Esprit to us of 15 percent to 25 percent of ProQuin XR net sales in the United States,
based on escalating net sales and subject to certain minimum royalty amounts. Esprit's minimum royalty amount for 2006 was $4.6 million and under our amended license agreement entered into in
July 2006, amounts paid by Esprit for 2005 royalties were creditable against the 2006 minimum royalty obligation. Net sales of ProQuin XR by Esprit for 2005 and 2006 did not reach levels that would
obligate Esprit to pay an amount greater than the minimum royalty obligation, and accordingly, Esprit paid us $4.6 million in total royalties for 2005 and 2006. In July 2007, we terminated our
license agreement with Esprit, and Esprit paid us $2.5 million in royalties, representing a pro-rated amount of minimum royalties that would have been due to us under the original
agreements. Esprit is no longer obligated to pay us royalties on ProQuin XR sales.

GLUMETZA
royalties relate to royalties we received from Biovail based on net sales of GLUMETZA in Canada and royalties we received from LG based on net sales of LG's version of GLUMETZA,
Novamet GR, in Korea. We began receiving royalties from Biovail in the first quarter of 2006 and from LG in the first quarter of 2007.

As
a result of the termination of the Esprit agreements, we expect royalty revenue to decrease in 2008.

License revenue

Our license agreement with Esprit for ProQuin XR provided for $50.0 million in license fees from Esprit. We received $30.0 million in license fees
in July 2005 and an additional $10.0 million in December 2006. The final $10.0 million installment was due in July 2007. The first $40.0 million in license fees received were
recognized as revenue ratably commencing on our receipt of the fees through June 2020, which represented the length of time we were obligated to manufacture ProQuin XR under our ProQuin XR supply
agreement with Esprit. In July 2007, we and Esprit terminated the license and supply agreements.

As
a result of the termination of our agreements with Esprit, we no longer have continuing obligations to Esprit. Accordingly, all deferred revenue related to license fees previously
received from Esprit was fully recognized as revenue in July 2007, resulting in recognition of approximately $36.1 million of license revenue. In addition, the final $10 million payment
received in July 2007 was fully recognized as license revenue on receipt, resulting in total recognition of $46.1 million of license revenue related to our agreements with Esprit during the
third quarter of 2007.

We
received $25.0 million in GLUMETZA license fees from Biovail in July 2005. We are recognizing the $25.0 million license fee payment as revenue ratably until February
2023, which represents the estimated length of time our obligations exist under the arrangement related to royalties we are obligated to pay Biovail on net sales of GLUMETZA in the United States and
for our obligation to use Biovail as our sole supplier of the 1000mg GLUMETZA, should the 1000mg GLUMETZA obtain approval in the United States. At December 31, 2007, we have
$22.0 million remaining in deferred revenue related to this agreement.

We
received a $0.6 million upfront license fee from LG in August 2004 and a $0.5 million milestone payment received in November 2006 with respect to LG's approval to market
Novamet GR in the Republic of Korea. These payments were originally deferred and amortized as license revenue over the estimated length of time we were obligated to provide assistance in development
and

49

---



manufacturing.
In January 2007, we amended our agreement with LG, granted LG a license to certain of the Company's intellectual property rights to manufacture the 500mg Novamet GR in exchange for
royalties on net sales of Novamet GR in Korea, and removed the provisions of the original agreement providing for the supply of 500mg Novamet GR tablets by us to LG. Under the amended agreement, we no
longer have continuing performance obligations that are other than inconsequential or perfunctory to LG. Accordingly, the remaining $0.9 million of previously deferred revenue was recognized as
license revenue in the first quarter of 2007.

In
February 2007, we received $0.5 million from Biovail upon entering into a license and development agreement with Biovail granting Biovail an option to license our AcuForm drug
delivery technology to develop and commercialize up to two pharmaceutical products. We have no continuing performance obligations that are other than inconsequential or perfunctory under the
agreement. Accordingly, we have recognized the entire upfront license fee as revenue in the first quarter of 2007.

As
a result of the termination of the Esprit agreements, we expect license revenue to decrease in 2008.

Collaborative revenue

Collaborative revenue decreased in 2007 from 2006 as a result of services performed for Esprit, which were completed in 2006. Collaborative revenue decreased in
2006 from 2005 as a result of services performed in 2005 under our agreement with Boehringer Ingelheim Pharmaceuticals, which were completed in December 2005.

Cost of Sales

Cost of sales consists of costs of the active pharmaceutical ingredient, contract manufacturing and packaging costs, product quality testing, internal employee
costs related to the manufacturing process, distribution costs and shipping costs related to our product sales. Total costs of sales are summarized in the following table (in thousands):

2007

2006

2005Cost of sales

$
2,597

$
1,601

$
908


Cost
of sales increased in 2007 over 2006 primarily as a result of an increase in GLUMETZA product sales and increased in 2006 over 2005 as a result of an increase in supply of ProQuin
XR to Esprit. The costs of manufacturing associated with deferred revenue on GLUMETZA and ProQuin XR product shipments are recorded as deferred costs, which are included in inventory, until such time
the deferred revenue is recognized.

50

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Research and Development Expense

Our research and development expenses currently include costs for scientific personnel, supplies, equipment, outsourced clinical and other research activities,
consultants, depreciation, facilities and utilities. The scope and magnitude of future research and development expenses cannot be predicted at this time for our product candidates in the early phases
of research and development, as it is not possible to determine the nature, timing and extent of clinical trials and studies, the FDA's requirements for a particular drug and the requirements and
level of participation, if any, by potential partners. As potential products proceed through the development process, each step is typically more extensive, and therefore more expensive, than the
previous step. Success in development therefore, generally results in increasing expenditures until actual product launch. Total research and development expense for the each of the three years ended
December 31, 2007 were as follows (in thousands):

2007

2006

2005Research and development expense

$
23,337

$
26,891

$
18,369Dollar change from prior year


(3,554
)

8,522Percentage change from prior year


(13
)%

46
%


In
2006 and 2007, the majority of our research and development expense was related to Gabapentin GR. The decrease in research and development expense in 2007 from 2006 was primarily due
to reduced expense related to the completion of our Phase 3 clinical trials for Gabapentin GR for the treatment of postherpetic neuralgia partially offset by the commencement of a
Phase 2 clinical trial for Gabapentin GR for the treatment of menopausal hot flashes in 2007.

The
increase in research and development expense in 2006 from 2005 was primarily due to completion of our Phase 2 and commencement of our Phase 3 clinical trials for
Gabapentin GR for the treatment of postherpetic neuralgia and completion of our Phase 2 clinical trial for Gabapentin GR for the treatment of diabetic peripheral neuropathy. The adoption of
FAS 123(R) on January 1, 2006 resulted in an increase in stock compensation expense of $1.0 million for 2006.

We
categorize our research and development expense by project. The table below shows research and development costs for our major clinical development programs, as well as other expenses
associated with all other projects in our product pipeline.

2007

2006

2005Gabapentin GR (PHN and DPN)

$
13,928

$
23,358

$
12,336Gabapentin GR (Hot Flashes)


4,114


637


ProQuin XR








2,250Other projects


5,295


2,896


3,783Total research and development expenses

$
23,337

$
26,891

$
18,369


51

---



The
following table summarizes our principal product development initiatives as of March 2008. In addition to the products listed in the table below, from time to time we may enter into
feasibility studies with collaborative partners that, if successful, may be followed by definitive agreements to advance development of the product candidate.

|Program                   |  | Potential Indications                                                        |  | Development Status                                                     
|------------------------- |  | ---------------------------------------------------------------------------- |  | -----------------------------------------------------------------------
|Gabapentin GR             |  | Postherpetic neuralgia
Menopausal hot flashes
Diabetic peripheral neuropathy |  | Phase 3 trial underway.
Phase 2 trial complete.
Phase 2 trial complete.
|Omeprazole                |  | Gastroesophageal reflux disease (GERD)                                       |  | Phase 2a proof of concept studies complete.                            
|Undisclosed compound      |  | Confidential(1)                                                              |  | Preclinical studies.Partnered with Supernus Pharmaceuticals, Inc.      
|Two undisclosed compounds |  | Confidential                                                                 |  | Preclinical studies.                                                   

---

We
expect that the pharmaceutical products that we develop internally will take, on average, from four to eight years to research, develop and obtain FDA approval in the United States,
assuming that we are successful. We generally must conduct preclinical testing on laboratory animals of new pharmaceutical products prior to commencement of clinical studies involving human beings.
These studies evaluate the potential efficacy and safety of the product. We then submit the results of these studies to the FDA as part of an Investigational New Drug Application, or IND, which, if
successful, allows the opportunity for clinical study of the potential new medicine.

Typically,
human clinical evaluation involves a time-consuming and costly three-phase process:



The
most significant expenses associated with clinical development derive from the Phase 3 trials as they tend to be the longest and largest studies conducted during the drug
development process. In March 2008, we commenced an additional Phase 3 trial for Gabapentin GR for the treatment of postherpetic neuralgia, and expect to commence a Phase 3 trial for
Gabapentin GR for the treatment of menopausal hot flashes either alone or with a collaborative partner, which may result in increased research and development expense in 2008.

The
successful development of pharmaceutical products is highly uncertain. The FDA closely monitors the progress of each phase of clinical testing. The FDA may, at its discretion,
re-evaluate, alter, suspend or terminate testing based upon the data accumulated to that point and the FDA's assessment of the risk/benefit ratio to patients. The FDA may also require
additional clinical trials after

52

---



approval,
which are known as Phase 4 trials. Various statutes and regulations also govern or influence the manufacturing, safety, labeling, storage and record keeping for each product. The
lengthy process of seeking FDA approvals, and the subsequent compliance with applicable statutes and regulation, require the expenditure of substantial resources.

Selling, General and Administrative Expense

Selling, general and administrative expenses primarily consist of personnel expenses to support our operating activities, marketing and promotion expenses
associated with GLUMETZA, facility costs and professional expenses, such as legal and accounting fees. Total selling, general and administrative expenses, as compared to the prior year, were as
follows:

2007

2006

2005Selling, general and administrative expenses

$
26,694

$
22,666

$
11,639Dollar change from prior year


4,028


11,027Percentage change from prior year


18
%

95
%


In
2004, we announced our determination to evolve from a solely product development focused company to an integrated specialty pharmaceutical company with sales and marketing of our own
products. Preliminary staffing for these activities began in 2005. In 2006 and 2007, we enhanced our internal sales and marketing capabilities through the hiring of additional sales and marketing
employees and the engagement of consultants. We anticipate the build-up of our commercial infrastructure will continue over the next several years.

The
increase in selling, general and administrative expense in 2007 from 2006 was primarily due to an increase of approximately $1.8 million in expense related to marketing costs
associated with GLUMETZA, an increase of $1.5 million in legal fees due to our patent infringement case against IVAX and an increase of $0.6 million increase in promotion fees due to
King under the promotion agreement related to GLUMETZA.

The
increase in selling, general and administrative expense in 2006 from 2005 was primarily due to approximately $3.0 million in expense related to marketing costs associated with
GLUMETZA, which was launched in September 2006, $2.4 million in related promotion fees due to King under the promotion agreement related to GLUMETZA, an increase of $1.7 million in legal
fees due to our patent infringement case against IVAX, and an increase in stock compensation expense of $1.2 million as a result of the adoption of FAS 123(R) on January 1, 2006.

We
expect that selling, general and administrative expense will be flat or slightly higher in 2008 from 2007 levels, but this may change based on the terms of any agreement, if any, that
we may enter into with a promotion partner with respect to GLUMETZA.

Interest Income and Expense

2007

2006

2005Interest income

$
2,273

$
2,031

$
1,445Interest expense








(460
)Net interest income (expense)

$
2,273

$
2,031

$
985


Interest
income increased in 2007 over 2006 due to higher investment balances in 2007 resulting from of our receipt of $29.7 million in termination fees from King and
$17.5 million in license and termination fees from Esprit in the second half of 2007. Interest income increased in 2006 over 2005 due to higher investment balances in 2006 resulting from of our
receipt of license fees from Esprit and Biovail in 2005 and also due to higher interest rates earned on our investment portfolio. Interest

53

---



expense
in 2005 was mainly due to interest on a promissory note, issued to Elan Corporation plc, or Elan. The note was fully repaid in June 2005.

Gain on Termination of King Promotion Agreement

In conjunction with the termination and assignment agreement entered into with King in October 2007, we received a $29.7 million termination payment from
King, of which $29.6 million has been classified as a gain within operating income for the year ended December 31, 2007.

Gain on Termination of Esprit Pharma Agreement

In conjunction with the termination and assignment agreement entered into with Esprit in July 2007, we received a $5.0 million termination payment from
Esprit, which has been classified as a gain within operating income for the year ended December 31, 2007.

Gain from Extinguishment of Debt

In connection with the formation of DDL, an Elan joint venture, Elan made a loan facility available to us for up to $8.0 million in principal to support
our 80.1% share of the joint venture's research and development costs pursuant to a convertible promissory note issued by us to Elan. The funding term of the loan expired in November 2002. The note
had a six-year term, was due in January 2006, and bore interest at 9% per annum, compounded semi-annually, on any amounts borrowed under the facility. However, in June 2005, we
repurchased the promissory note with an outstanding balance of $10.7 million, including $2.9 million of accrued interest, for $9.7 million including commissions paid to a
financial consultant and legal fees. A gain on the extinguishment of the debt of $1.1 million was recorded in other income in 2005.

Series A Preferred Stock and Deemed Dividends

In January 2000, we issued 12,015 shares of Series A Preferred Stock at a price of $1,000 per share. The Series A Preferred Stock accrued a dividend
of 7% per annum, compounded semi-annually and payable in shares of Series A Preferred Stock. The Series A Preferred Stock was convertible at anytime between January 2002 and
January 2006 into our common stock. The original conversion price of the Series A Preferred Stock was $12.00. However, as a result of our March 2002 and October 2003 financings, the conversion
price was adjusted to $9.51 per share. In December 2004, we entered into an agreement with the Series A Preferred shareholder to resolve a misunderstanding between us and the shareholder
relating primarily to prior adjustments to the conversion price of the Series A Preferred Stock (the December 2004 Agreement). Pursuant to the December 2004 Agreement, among other matters, we
agreed to adjust the conversion price to $7.50 per share. We and the shareholder also agreed to binding interpretations of certain other terms related to the Series A conversion price.

Prior
to December 2004, the amounts calculated as Series A Preferred stock dividends were accounted for as an adjustment to the conversion price following EITF Issue
No. 98-5,Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios(Issue No. 98-5). As a result of the December 2004 Agreement, we determined that a significant modification of the preferred stock agreement had occurred, and, therefore, a new
commitment date was established for the Series A Preferred Stock. Further, we determined that the fair value of the modified preferred stock was below the carrying value of such securities as
of the date of the modification, therefore, no deemed dividend resulted from this modification. Also, we determined that although a new commitment date had been established, this change did not result
in a beneficial conversion feature subject to recognition pursuant to Emerging Issues Task Force Issue No. 00-27,Application of Issue
No. 98-5 to Certain Convertible Instruments. However, an anti-dilution provision of the Series A Preferred Stock was triggered by our
January 2005 financing, which adjusted the

54

---



conversion
price of the Series A Preferred Stock to $7.12. As a result of the adjusted conversion price and an increase in the amount of common stock issuable upon conversion of the
Series A Preferred Stock due to additional accumulated dividends, the Series A Preferred Stock now contains a "beneficial conversion feature" subject to recognition pursuant to Issue
No. 98-5.

In
conjunction with the modification of the agreement, we issued a warrant to the Series A Preferred shareholder. The value of the warrant was considered in determining the value
of the modified security. The warrant is convertible into shares of our common stock during the period between January 2006 and January 2009. The conversion price of the warrant initially was $7.12,
which was equal to the Series A Preferred Stock conversion price in effect as of January 20, 2006. The conversion price of the warrant decreases by approximately 4.8% per year during the
conversion period, such that the number of shares of our common stock issuable upon conversion of the warrant will increase by approximately 5.1% per year. The conversion of the warrant may be
satisfied only by surrender of the outstanding shares of Series A Preferred Stock.

The
Series A Preferred Stock accrued dividends through January 20, 2006, the date the warrant initially became exercisable. As a result of the issuance of the warrant, the
preferred stock may be surrendered in exchange for common stock for an additional three years through January 20, 2009. As long as the Series A Preferred Stock remains outstanding, the
number of shares into which the warrant can be converted increases as the conversion price of the warrant decreases resulting in additional deemed dividends on the Series A Preferred Stock. For
the years ended December 31, 2007, 2006 and 2005 we recognized Series A Preferred Stock deemed dividends of approximately $0.7 million, $0.7 million and
$0.8 million, respectively, attributable to the beneficial conversion feature from the accrued dividends and decreasing warrant price. We will continue to recognize Series A Preferred
Stock deemed dividends until the earlier of the time the Series A Preferred Stock is surrendered or January 2009.

As
of December 31, 2007, there were 18,158 shares of Series A Preferred Stock outstanding with an aggregate liquidation preference of approximately $18.2 million.
The warrant was convertible into 2,807,707 shares of our common stock at a conversion price of $6.47 as of December 31, 2007.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31,2007

2006Cash, cash equivalents and marketable securities (in thousands)

$
69,523

$
33,558


Since
inception through December 31, 2007, we have financed our product development efforts and operations primarily from private and public sales of equity securities and
receipts of upfront license and termination fees from collaborative and license partners.

In
December 2006, we entered into a common stock purchase agreement with Azimuth Opportunity, Ltd., pursuant to which Azimuth is committed to purchase, from time to time and at
our sole discretion, up to the lesser of (a) $30.0 million of our common stock, or (b) 8,399,654 shares of common stock. Sales to Azimuth under the agreement, if any, will occur
over a 24-month term and will be made at a price equal to the average closing price of our common stock over a given pricing period, minus a discount ranging from approximately 3.8% to
6.4%, which varies based on a threshold price set by us. Upon each sale of the our common stock to Azimuth under the agreement, we have also agreed to pay Reedland Capital Partners a placement fee
equal to approximately 1.1% of the aggregate dollar amount of common stock purchased by Azimuth. Azimuth is not required to purchase our common stock when the price of our common stock is below $2 per
share. As of December 31, 2007, we have not sold any common stock to Azimuth under this common stock purchase agreement.

55

---



In April 2007, we completed a registered direct offering of 5,300,000 shares of common stock with institutional investors. The shares were sold at a price of approximately $3.78 per
share, with net proceeds totaling approximately $20.0 million.

In
July 2007, Esprit paid us $17.5 million in connection with the termination of our license and supply agreement related to ProQuin XR.

In
October 2007, King paid us $29.7 million in connection with the termination of our promotion agreement with GLUMETZA.

As
of December 31, 2007, we have accumulated net losses of $134.9 million. We expect to continue to incur operating losses in 2008. We anticipate that our existing capital
resources will permit us to meet our capital and operational requirements through at least the end of 2008. We base this expectation on our current operating plan, which may change as a result of many
factors.

Our
cash needs may also vary materially from our current expectations because of numerous factors, including:



We
will need substantial funds of our own or from third parties to:



The
following table summarizes our cash flow activities (in thousands):

2007

2006

2005Cash provided by (used in) operating activities

$
14,661

$
(27,700
)
$
28,817Cash provided (used in) by investing activities


(35,986
)

31,764


(34,822
)Cash provided by financing activities


21,125


2,944


12,618


Cash
provided by operations for 2007 primarily consisted to our net income adjusted for stock-based compensation, depreciation expense and movements in working capital, including
recognition of previously deferred revenue. In 2006, cash used in operating activities was primarily our net loss for the year adjusted for stock-based compensation, depreciation expense and movements
in working capital. In 2005, cash provided from operations was due primarily to increases in deferred revenue related to

56

---



license
payments received under our agreements with Esprit and Biovail, partially offset by our net loss for the year.

Cash
used in investing activities in 2007 was due to a net increase in marketable securities of $35.8 million resulting from investment of termination fees received from King and
the final license fee payment and termination fee received from Esprit. Cash provided by investing activities in 2006 was due to a $32.5 million net decrease in marketable securities partially
offset by $0.8 million in purchases of laboratory and office equipment. Cash used in investing activities in 2005 consisted of a net increase in marketable securities of $34.0 million
resulting from investment of license fees received under our agreements with Esprit and Biovail and $0.8 million in purchases of lab and office equipment.

Cash
provided from financing activities in 2007 consisted of $20.0 million in proceeds from our registered direct offering of 5,300,000 shares of common stock for $3.78 per share
in April 2007 and $1.2 million in cash proceeds from exercises of stock options and purchases of common stock under our employee stock purchase plan. Cash provided from financing activities in
2006 consisted of $2.9 million of proceeds from exercises of stock options, warrants and purchases of common stock under our employee stock purchase plan. Cash provided from financing
activities in 2005 consisted primarily of net proceeds of $21.0 million from our registered direct public offering of 5,036,000 shares of common stock for $4.50 per share in January 2005 and
$1.4 million in proceeds from the exercise of stock options, warrants and purchases of common stock under our employee stock purchase plan, which were partially offset by the repayment of the
Elan promissory note of $9.7 million and $0.1 million in payments on equipment loans and capital lease obligations.

Contractual Obligations

As of December 31, 2007, our contractual obligations are shown in the following table (in thousands):

Less than
1 year

1-3 years

3-5 years

TotalOperating leases

$
1,441

$
845

$
6

$
2,292Related party arrangements


498








498Purchase commitments


655








655$
2,594

$
845

$
6

$
3,445


At
December 31, 2007, we had non-cancelable purchase orders and minimum purchase obligations for 2007 of approximately $0.7 million under our manufacturing
agreement with MOVA Pharmaceuticals for the manufacture of GLUMETZA. The amounts disclosed only represent minimum purchase requirements. Actual purchases are expected to exceed these amounts.

We
have a consulting arrangement with John W. Fara, Ph.D., our former Chairman, President and Chief Executive and current member of the Company's Board of Directors and are obligated to
pay Dr. Fara $250,000 for consulting services in 2008. We also have a consulting arrangement with John F. Hamilton, our former Vice President, Finance and Chief Financial Officer and are
obligated to pay Mr. Hamilton $248,000 for consulting services in 2008.

The
contractual obligations reflected in this table exclude $3.5 million of contingent milestone payments we may be obligated to pay in the future under our sublicense agreement
with PharmaNova. These payments relate to various milestones for the product candidate under the sublicense agreement, including dosing of the first patient in any Phase 3 trial, submission to
the FDA of an NDA, and FDA approval of an NDA. The above table also excludes any future royalty payments we may be required to pay on products we have licensed or any promotion fees associated with
our promotion agreement with Watson.

57

---



OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future material effect on our financial condition,
results of operations, liquidity, capital expenditures or capital resources.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157,Fair Value
Measurements(SFAS 157), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures
about fair value measurements. SFAS No. 157 is effective for us beginning January 1, 2008. We do not expect the adoption of SFAS No. 157 to have a material impact on our
consolidated financial statements.

In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities(SFAS 159). SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial
statements issued for us beginning January 1, 2008. We do not expect the adoption of SFAS No. 159 to have a material impact on our consolidated financial statements.

In
December 2007, the FASB ratified the final consensus in Emerging Issues Task Force (EITF) Issue No. 07-1,Accounting for Collaborative
Arrangements(EITF 07-1), which requires certain income statement presentation of transactions with third parties and of payments between parties of the
collaborative arrangement, along with disclosure about the nature and purpose of the arrangement. EITF 07-1 is effective for us beginning January 1, 2009. We do not expect
the adoption of EITF 07-1 to have a material impact on our consolidated financial statements.

In
June 2007, the FASB ratified EITF issue No. 07-3,Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in
Future Research and Development Activities(EITF 07-3). EITF 07-3 that nonrefundable advance payments for goods and services that will be
used or rendered in future R&D activities pursuant to contractual arrangements be deferred and recognized as expense in the period that the related goods are delivered or services are performed.
EITF 07-3 is effective for us beginning January 1, 2008. We do not expect the adoption of EITF 07-3 to have a material impact on our consolidated financial
statements.

58

---





ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

We consider all highly liquid investments with an original maturity (at date of purchase) of three months or less to be cash equivalents. At December 31,
2007, our marketable securities available for sale consisted of U.S. corporate debt and U.S. debt securities with maturity dates of less than two years. Our investments in U.S. corporate debt
securities consist primarily of investments in investment grade corporate bonds and notes. Our investments in U.S. government debt securities consist of low risk government agency bonds typically with
a rating of A or higher. Our operating results have not been sensitive to changes in the general level of interest rates in the United States, particularly because most of our marketable securities
are invested in short-term debt instruments.

As
of December 31, 2007, the principal amounts, fair values and related weighted-average interest rates of our investments in debt securities classified as marketable securities
available-for-sale were as follows:

DurationLess than 1 year

1 to 2 years

TotalPrincipal amount

$
39,036

$
16,002

$
55,038Fair value

$
39,091

$
16,058

$
55,149Average interest rate


5.06
%

4.34
%

4.85
%


Foreign Currency Risk

We have not had any significant transactions in foreign currencies, nor did we have any significant balances that were due or payable in foreign currencies at
December 31, 2007. Accordingly, significant changes in foreign currency rates would not have a material impact on our financial position and results of operations.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements required by this item are set forth beginning on page 68 of this report and are incorporated herein by reference.

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.    CONTROLS AND PROCEDURES



At the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our
principal executive officer and interim principal accounting and financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our interim
principal accounting and financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2007 to ensure that information to be disclosed by us in this
Annual Report on Form 10-K was recorded, processed summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and
Form 10-K.

59

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We
maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to our management, including our chief
executive officer and interim principal accounting and financial officer, as appropriate, to allow for timely decisions regarding required disclosure. There were no changes in our internal controls
over financial reporting during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We
intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to correct any material deficiencies that we may discover.
Our goal is to ensure that our management has timely access to material information that could affect our business. While we believe the present design of our disclosure controls and procedures is
effective to achieve our goal, future events affecting our business may cause us to modify our disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is
required to
apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.



Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act
Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and interim principal accounting and financial
officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal ControlIntegrated
Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework inInternal
ControlIntegrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.

60

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Report of Independent Registered Public Accounting Firm

The
Board of Directors and Shareholders
Depomed, Inc.

We
have audited Depomed, Inc.'s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Depomed, Inc.'s management is responsible for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and
performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In
our opinion, Depomed, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Depomed, Inc. as of
December 31, 2007 and 2006, and the related consolidated statements of operations, redeemable preferred stock and shareholders' equity (deficit), and cash flows for each of the three years in
the period ended December 31, 2007 of Depomed, Inc. and our report dated March 12, 2008 expressed an unqualified opinion thereon.



Palo
Alto, California
March 12, 2008

61

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ITEM 9B.    OTHER INFORMATION

In March 2008, we subleased approximately 9,000 square feet of laboratory and office facilities in Menlo Park, California. The sublease term is through June 2009
with an option to extend the lease for an additional five years.

PART III

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item with respect to executive officers is set forth in Part I of this report and the information with respect to
directors and corporate governance matters is incorporated by reference to the information set forth under the caption "Election of Directors" in the company's Proxy Statement for the 2008 Annual
Meeting of Shareholders.

The
section entitled "Compliance Under Section 16(a) of the Securities Exchange Act of 1934" appearing in the Proxy Statement for the 2008 Annual Meeting of Shareholders sets
forth the information concerning compliance by officers, directors and 10% shareholders of the company with Section 16 of the Exchange Act of 1934 and is incorporated herein by reference.

ITEM 11.    EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by reference to the information set forth under the caption "Executive Compensation" in the Proxy
Statement for the 2008 Annual Meeting of Shareholders.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS

The information required by this Item is incorporated herein by reference to the information set forth under the caption "Security Ownership of Certain Beneficial
Owners and Management and Related Shareholder Matters" in the Proxy Statement for the 2008 Annual Meeting of Shareholders.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this Item is incorporated herein by reference to the information set forth under the captions "Directors" and "Certain Relationships
and Related Transactions" in the Proxy Statement for the 2008 Annual Meeting of Shareholders.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item is incorporated herein by reference to the information set forth under the caption "Principal Accountant Fees and Services"
in the Proxy Statement for the 2008 Annual Meeting of Shareholders.

62

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PART IV

ITEM 15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)

1.    Financial Statements



2.    Financial Statement Schedules

Schedule II is included on page 105 of this report. All other schedules are omitted because they are not required or the required information is
included in the financial statements or notes thereto.

3.    Exhibits:

|Exhibit |  | Footnote |   | Description of Document                                                                                                                                                                          
|------- |  | -------- | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1     |  | (1       | ) | Amended and Restated Articles of Incorporation                                                                                                                                                   
|3.2     |  | (2       | ) | Certificate of Amendment to Amended and Restated Articles of Incorporation                                                                                                                       
|3.3     |  | (3       | ) | Certificate of Determination of Rights and Preferences of Series A Preferred Stock filed with the State of California on January 14, 2000                                                        
|3.4     |  | (4       | ) | Certificate of Determination of Series RP Preferred Stock of the company                                                                                                                         
|3.5     |  | (5       | ) | Bylaws, as amended                                                                                                                                                                               
|4.1     |  | (6       | ) | Form of Subscription Agreement dated as of May 2, 2001                                                                                                                                           
|4.2     |  | (6       | ) | Supplement to Form of Subscription Agreement dated as of May 29, 2001                                                                                                                            
|4.3     |  | (6       | ) | Form of Warrant dated as of June 13, 2001                                                                                                                                                        
|4.4     |  | (7       | ) | Form of Subscription Agreement dated as of March 14, 2002                                                                                                                                        
|4.5     |  | (7       | ) | Placement Agent Warrant dated as of March 14, 2002                                                                                                                                               
|4.6     |  | (8       | ) | Stock Purchase Agreement, dated as of May 28, 2002, between the Company and Biovail Laboratories International SRL                                                                               
|4.7     |  | (9       | ) | Amendment No. 1 to Stock Purchase Agreement, dated as February 7, 2007, between the Company and Biovail Laboratories International SRL                                                           
|4.8     |  | (10      | ) | Form of Warrant dated as of April 21, 2003                                                                                                                                                       
|4.9     |  | (10      | ) | Depomed, Inc. Securities Purchase Agreement, dated as of April 21, 2003                                                                                                                          
|4.10    |  | (11      | ) | Form of Warrant to purchase common stock dated December 10, 2004 (see Exhibit A of Exhibit 10.13 below)                                                                                          
|4.11    |  | (12      | ) | Rights Agreement, dated as of April 21, 2005, between the company and Continental Stock Transfer and Trust Company as Rights Agent                                                               
|10.1    |  | (13      | ) | 1995 Stock Option Plan, as amended                                                                                                                                                               
|10.2    |  | (9       | ) | Form of Incentive Stock Option Agreement under 1995 Stock Option Plan                                                                                                                            
|10.3    |  | (9       | ) | Form of Nonstatutory Stock Option Agreement under 1995 Stock Option Plan                                                                                                                         
|10.4    |  | (9       | ) | Form of Exercise Notice under 1995 Stock Option Plan                                                                                                                                             
|10.5    |  | (1       | ) | Agreement re: Settlement of Lawsuit, Conveyance of Assets and Assumption of Liabilities dated August 28, 1995 by and among Depomed Systems, Inc., Dr. John W. Shell and M6 Pharmaceuticals,
 Inc.
|10.6    |  | (14      | ) | Form of Indemnification Agreement between the Company and its directors and executive officers                                                                                                   

63

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|10.7  |   | (15 | ) | Settlement and Release Agreement, dated as of November 22, 2002, between the Company and Bristol-Myers Squibb Company                    
|----- | - | --- | - | -----------------------------------------------------------------------------------------------------------------------------------------
|10.8  |   | (16 | ) | Lease extension agreement dated April 30, 2003 between the Company and Menlo Business Park LLC                                           
|10.9  |   | (16 | ) | Lease agreement dated April 30, 2003 between the Company and Menlo Park Business Park LLC                                                
|10.10 |   | (17 | ) | 2004 Equity Incentive Plan, as amended                                                                                                   
|10.11 |   | (17 | ) | 2004 Employee Stock Purchase Plan, as amended                                                                                            
|10.12 |   | (11 | ) | Agreement, dated as of December 10, 2004, between the Company and Kings Road Investments, Ltd.                                           
|10.13 |   | (18 | ) | Offer Letter, dated June 14, 2005, between the Company and Carl Pelzel                                                                   
|10.14 | * | (14 | ) | Amendment No. 1 to Exclusive License and Marketing Agreement between the Company and Esprit Pharma, Inc., dated as of July 24, 2006      
|10.15 | * | (19 | ) | Technology Transfer and Commercial Manufacturing Agreement dated October 18, 2005 between the Company and MOVA Pharmaceutical Corporation
|10.16 | + | (19 | ) | Amended and Restated License Agreement dated December 13, 2005 between the Company and Biovail Laboratories International SRL            
|10.17 | + | (19 | ) | Supply Agreement dated December 13, 2005 between the Company and Biovail Laboratories International SRL                                  
|10.18 | + | (19 | ) | Manufacturing Transfer Agreement dated December 13, 2005 between the Company and Biovail Laboratories International SRL                  
|10.19 |   | (20 | ) | Description of Non-employee Director Compensation Policy, as amended                                                                     
|10.20 |   | (21 | ) | Bonus Plan of the Company, as amended                                                                                                    
|10.21 |   |     |   | Form of Management Continuity Agreement between the Company and certain officers of the Company                                          
|10.22 |   | (23 | ) | Offer Letter, dated June 14, 2006, between the Company and Matthew Gosling                                                               
|10.23 | * | (24 | ) | Promotion Agreement, dated as of June 27, 2006, between the Company and King Pharmaceuticals, Inc.                                       
|10.24 | * | (14 | ) | Co-Promotion Agreement dated July 24, 2006 between the Company and Esprit Pharma, Inc.                                                   
|10.25 |   | (14 | ) | Lease Agreement dated July 28, 2006 between the Company and Menlo Business Park, LLC                                                     
|10.26 |   | (14 | ) | Lease Extension Agreement dated July 28, 2006 between the Company and Menlo Business Park, LLC                                           
|10.27 |   | (14 | ) | Second Lease Extension Agreement dated July 28, 2006 between the Company and Menlo Business Park, LLC                                    
|10.28 | + | (9  | ) | Sublicense Agreement dated October 13, 2006 between the Company and PharmaNova, Inc.                                                     
|10.29 |   | (25 | ) | Common Stock Purchase Agreement dated December 11, 2006 between the Company and Azimuth Opportunity Ltd. dated December 11, 2006         
|10.30 | + | (9  | ) | Commercial Manufacturing Agreement dated December 19, 2006 between the Company and MOVA Pharmaceutical Corporation                       
|10.31 |   | (26 | ) | Form of Common Stock Purchase Agreement between Depomed, Inc. and selected institutional investors dated April 20, 2007                  
|10.32 |   | (17 | ) | Amendment to Supply Agreement dated June 30, 2007 between the Company and Biovail Laboratories International SRL                         
|10.33 |   | (27 | ) | Consulting Agreement dated August 24, 2007 between the Company and John W. Fara, Ph.D.                                                   
|10.34 |   | (27 | ) | Offer Letter, dated August 24, 2007, between the Company and Carl A. Pelzel                                                              

64

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|10.35 |   | (28 | ) | Consulting Agreement dated October 10, 2007 between the Company and John F. Hamilton                          
|----- | - | --- | - | --------------------------------------------------------------------------------------------------------------
|10.36 |   | (28 | ) | Letter Agreement dated October 10, 2007 between the Company and John F. Hamilton                              
|10.37 | + | (29 | ) | Termination and Assignment Agreement dated July 7, 2007 between the Company and Esprit Pharma, Inc.           
|10.38 | + | (29 | ) | Amended and Restated Promotion Agreement dated September 21, 2007 between the Company and Watson Pharma, Inc. 
|10.39 |   |     |   | Termination and Assignment Agreement dated October 29, 2007 between the Company and King Pharmaceuticals, Inc.
|10.40 |   |     |   | Amendment to Offer Letter, dated February 18, 2008, between the Company and Carl A. Pelzel                    
|23.1  |   |     |   | Consent of Independent Registered Public Accounting Firm                                                      
|24.1  |   |     |   | Power of Attorney (See Page 67)                                                                               
|31.1  |   |     |   | Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of Carl A. Pelzel          
|31.2  |   |     |   | Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of Tammy L. Cameron                
|32.1  |   |     |   | Certification pursuant to 18 U.S.C. Section 1350 of Carl A. Pelzel                                            
|32.2  |   |     |   | Certification pursuant to 18 U.S.C. Section 1350 of Tammy L. Cameron                                          

---

65

---



66

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the issuer, a corporation organized and existing under the laws
of the State of California, has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Menlo Park, State of California, on the
12th day of March 2008.

| |  | DEPOMED, INC.
| |  | -------------
| |  | By:          

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Carl A. Pelzel and Tammy L. Cameron, and each
of them acting individually, as his true and lawful attorneys-in-fact and agents, each with full power of substitution, for him in any and all capacities, to sign any and all
amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, with full power of each to act alone, full power and authority to do and perform each and every act and thing requisite and necessary to
be done in
connection therewith, as fully for all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or
his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed by the following persons
in the capacities and on the dates indicated.

|Signature                                         |  |                                                                     |  |               
|------------------------------------------------- |  | ------------------------------------------------------------------- |  | --------------
|                                                  |  |                                                                     |  |               
|/s/CARL A. PELZELCarl A. Pelzel                   |  | President and Chief Executive Officer
(Principal Executive Officer) |  | March 12, 2008
|/s/TAMMY L. CAMERONTammy L. Cameron               |  | Controller
(Interim Principal Accounting and Financial Officer)     |  | March 12, 2008
|/s/CRAIG R. SMITH, M.D.Craig R. Smith, M.D.       |  | Chairman of the Board of Directors                                  |  | March 12, 2008
|/s/G. STEVEN BURRILLG. Steven Burrill             |  | Director                                                            |  | March 12, 2008
|/s/JOHN W. FARA, PH.D.John W. Fara, Ph.D.         |  | Director                                                            |  | March 12, 2008
|/s/JAMES A. SCHOENECKJames A. Schoeneck           |  | Director                                                            |  | March 12, 2008
|/s/PETER D. STAPLEPeter D. Staple                 |  | Director                                                            |  | March 12, 2008
|/s/JULIAN N. STERNJulian N. Stern                 |  | Director and Secretary                                              |  | March 12, 2008
|/s/DAVID A. ZENOFF, D.B.A.David A. Zenoff, D.B.A. |  | Director                                                            |  | March 12, 2008

67

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DEPOMED, INC.    INDEX TO CONSOLIDATED FINANCIAL STATEMENTS    DEPOMED, INC. CONSOLIDATED FINANCIAL STATEMENTS

|Report of Independent Registered Public Accounting Firm  |  | 69
|-------------------------------------------------------- |  | --
|Consolidated Balance Sheets                              |  | 70
|Consolidated Statements of Operations                    |  | 71
|Consolidated Statement of Shareholders' Equity (Deficit) |  | 72
|Consolidated Statements of Cash Flows                    |  | 73
|Notes to Consolidated Financial Statements               |  | 74

68

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Shareholders
Depomed, Inc.

We
have audited the accompanying consolidated balance sheets of Depomed, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations,
shareholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index
at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule
based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Depomed, Inc. at December 31,
2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.

As
discussed in Note 1 to the consolidated financial statements, in 2006 Depomed, Inc. adopted Statement of Accounting Standards No. 123(R),
"Share-Based Payment", effective January 1, 2006.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Depomed, Inc.'s internal control over financial reporting
as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 12, 2008 expressed an unqualified opinion thereon.



Palo
Alto, California
March 12, 2008

69

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DEPOMED, INC.    CONSOLIDATED BALANCE SHEETS    (in thousands, except share amounts)

|                                               |                                                                                                                                                                                                                                                        | December 31,                         |       
|---------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------ | ------
|
|ASSETS                                         |                                                                                                                                                                                                                                                        |                                      |       
|Current assets:                                |                                                                                                                                                                                                                                                        |                                      |       
|                                               | Cash and cash equivalents                                                                                                                                                                                                                              |                                      | $     
|                                               | Marketable securities                                                                                                                                                                                                                                  |                                      |       
|                                               | Accounts receivable                                                                                                                                                                                                                                    |                                      |       
|                                               | Unbilled accounts receivable                                                                                                                                                                                                                           |                                      |       
|                                               | Inventories                                                                                                                                                                                                                                            |                                      |       
|                                               | Prepaid and other current assets                                                                                                                                                                                                                       |                                      |       
|                                               |                                                                                                                                                                                                                                                        |                                      |       
|                                               |                                                                                                                                                                                                                                                        | Total current assets                 |       
|Marketable securities                          |                                                                                                                                                                                                                                                        |                                      | 16,058
|Property and equipment, net                    |                                                                                                                                                                                                                                                        |                                      | 1,621 
|Other assets                                   |                                                                                                                                                                                                                                                        |                                      | 197   
|                                               |                                                                                                                                                                                                                                                        |                                      |       
|                                               |                                                                                                                                                                                                                                                        | $                                    | 80,645
|                                               |                                                                                                                                                                                                                                                        |                                      |       
|LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) |                                                                                                                                                                                                                                                        |                                      |       
|Current liabilities:                           |                                                                                                                                                                                                                                                        |                                      |       
|                                               | Accounts payable                                                                                                                                                                                                                                       |                                      | $     
|                                               | Accrued compensation                                                                                                                                                                                                                                   |                                      |       
|                                               | Accrued clinical trial expense                                                                                                                                                                                                                         |                                      |       
|                                               | Accrued promotion fee expense                                                                                                                                                                                                                          |                                      |       
|                                               | Other accrued liabilities                                                                                                                                                                                                                              |                                      |       
|                                               | Deferred product sales                                                                                                                                                                                                                                 |                                      |       
|                                               | Deferred license revenue                                                                                                                                                                                                                               |                                      |       
|                                               | Other current liabilities                                                                                                                                                                                                                              |                                      |       
|                                               |                                                                                                                                                                                                                                                        |                                      |       
|                                               |                                                                                                                                                                                                                                                        | Total current liabilities            |       
|Deferred license revenue, non-current portion  |                                                                                                                                                                                                                                                        |                                      | 20,763
|Other long-term liabilities                    |                                                                                                                                                                                                                                                        |                                      | 28    
|Commitments                                    |                                                                                                                                                                                                                                                        |                                      |       
|Shareholders' equity (deficit):                |                                                                                                                                                                                                                                                        |                                      |       
|                                               | Preferred stock, no par value, 5,000,000 shares authorized; Series A convertible preferred stock, 25,000 shares designated, 18,158 shares issued and outstanding as of December 31, 2007 and 2006, with an aggregate
liquidation preference of $18,159 |                                      |       
|                                               | Common stock, no par value, 100,000,000 shares authorized; 47,865,529 and 42,029,411 shares issued and outstanding at December 31, 2007 and 2006, respectively                                                                                         |                                      |       
|                                               | Accumulated deficit                                                                                                                                                                                                                                    |                                      |       
|                                               | Accumulated other comprehensive gain (loss)                                                                                                                                                                                                            |                                      |       
|                                               |                                                                                                                                                                                                                                                        |                                      |       
|                                               |                                                                                                                                                                                                                                                        | Total shareholders' equity (deficit) |       
|                                               |                                                                                                                                                                                                                                                        |                                      |       
|                                               |                                                                                                                                                                                                                                                        | $                                    | 80,645
|                                               |                                                                                                                                                                                                                                                        |                                      |       

See
accompanying notes to Consolidated Financial Statements.

70

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DEPOMED, INC.    CONSOLIDATED STATEMENTS OF OPERATIONS    (in thousands, except share and per share amounts)

|                                                                            |                                          | Year Ended December 31, |           
|--------------------------------------------------------------------------- | ---------------------------------------- | ----------------------- | ----------
|
|Revenues:                                                                   |                                          |                         |           
|                                                                            | Product sales                            |                         | $         
|                                                                            | Royalties                                |                         |           
|                                                                            | License revenue                          |                         |           
|                                                                            | Collaborative revenue                    |                         |           
|                                                                            |                                          |                         |           
|Total revenues                                                              |                                          |                         | 65,582    
|Costs and expenses:                                                         |                                          |                         |           
|                                                                            | Cost of sales                            |                         |           
|                                                                            | Research and development                 |                         |           
|                                                                            | Selling, general and administrative      |                         |           
|                                                                            | Gain on termination of King agreement    |                         |           
|                                                                            | Gain on termination of Esprit agreements |                         |           
|                                                                            |                                          |                         |           
|Total costs and expenses                                                    |                                          |                         | 18,044    
|                                                                            |                                          |                         |           
|Income (loss) from operations                                               |                                          |                         | 47,538    
|Other income (expenses):                                                    |                                          |                         |           
|                                                                            | Gain from extinguishment of debt         |                         |           
|                                                                            | Interest and other income                |                         |           
|                                                                            | Interest expense                         |                         |           
|                                                                            |                                          |                         |           
|Total other income (expenses)                                               |                                          |                         | 2,273     
|                                                                            |                                          |                         |           
|Net income (loss) before income taxes                                       |                                          |                         | 49,811    
|Provision for income taxes                                                  |                                          |                         | (592      
|                                                                            |                                          |                         |           
|Net income (loss)                                                           |                                          |                         | 49,219    
|Deemed dividend on preferred stock                                          |                                          |                         | (685      
|                                                                            |                                          |                         |           
|Net income (loss) applicable to common stock
shareholders                   |                                          | $                       | 48,534    
|                                                                            |                                          |                         |           
|Basic net income (loss) applicable to common stock shareholders per share   |                                          | $                       | 1.06      
|                                                                            |                                          |                         |           
|Diluted net income (loss) applicable to common stock shareholders per share |                                          | $                       | 1.05      
|                                                                            |                                          |                         |           
|Shares used in computing basic net income (loss)
per share                  |                                          |                         | 45,951,127
|                                                                            |                                          |                         |           
|Shares used in computing diluted net income (loss)
per share                |                                          |                         | 46,353,207
|                                                                            |                                          |                         |           

See
accompanying notes to Consolidated Financial Statements.

71

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DEPOMED, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands, except share amounts)

|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      | Accumulated
Other
Comprehensive
Income
(Loss) |   |          |        
|----------------------------------------------------------- | ------------------------------------------------ | ------ | - | - | ------ | - | ---------- | - | - | ------- | - | - | ---- | --------------------------------------------- | - | -------- | -------
|
|
|
|Balances at Dec. 31, 2004                                   |                                                  | 15,821 |   | $ | 12,015 |   | 34,691,190 |   | $ | 117,071 |   | $ | (622 | )                                             | $ | (119,985 | )      
|Issuance of common stock, net of issuance costs             |                                                  |       |   |   |       |   | 5,036,000  |   |   | 21,019  |   |   |     |                                               |   |         |        
|Issuance of common stock upon exercise of options           |                                                  |       |   |   |       |   | 234,468    |   |   | 709     |   |   |     |                                               |   |         |        
|Issuance of common stock upon exercise of warrants          |                                                  |       |   |   |       |   | 625,152    |   |   | 280     |   |   |     |                                               |   |         |        
|Issuance of common stock under employee stock purchase plan |                                                  |       |   |   |       |   | 102,559    |   |   | 381     |   |   |     |                                               |   |         |        
|Stock-based compensation                                    |                                                  |       |   |   |       |   |           |   |   | 215     |   |   |     |                                               |   |         |        
|Amortization of deferred stock-based compensation           |                                                  |       |   |   |       |   |           |   |   | (34     | ) |   | 285  |                                               |   |         |        
|Issuance of preferred stock                                 |                                                  | 1,722  |   |   |       |   |           |   |   |        |   |   |     |                                               |   |         |        
|Comprehensive loss:                                         |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|                                                            | Net loss                                         |        |  |   |        |  |            |  |   |         |  |   |      |                                              |   |          | (24,467
|                                                            | Unrealized loss on available-for-sale securities |        |  |   |        |  |            |  |   |         |  |   |      |                                              |   |          |       
|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|Comprehensive loss                                          |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|Balances at Dec. 31, 2005                                   |                                                  | 17,543 |   |   | 12,015 |   | 40,689,369 |   |   | 139,641 |   |   | (337 | )                                             |   | (144,452 | )      
|Change in classification upon adoption of FAS 123R          |                                                  |       |   |   |       |   |           |   |   | (337    | ) |   | 337  |                                               |   |         |        
|Issuance of common stock upon exercise of options           |                                                  |       |   |   |       |   | 228,006    |   |   | 476     |   |   |     |                                               |   |         |        
|Issuance of common stock upon exercise of warrants          |                                                  |       |   |   |       |   | 980,813    |   |   | 2,042   |   |   |     |                                               |   |         |        
|Issuance of common stock under employee stock purchase plan |                                                  |       |   |   |       |   | 131,223    |   |   | 426     |   |   |     |                                               |   |         |        
|Stock-based compensation                                    |                                                  |       |   |   |       |   |           |   |   | 2,572   |   |   |     |                                               |   |         |        
|Issuance of preferred stock                                 |                                                  | 615    |   |   |       |   |           |   |   |        |   |   |     |                                               |   |         |        
|Comprehensive loss:                                         |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|                                                            | Net loss                                         |        |  |   |        |  |            |  |   |         |  |   |      |                                              |   |          | (39,659
|                                                            | Unrealized gain on available-for-sale securities |        |  |   |        |  |            |  |   |         |  |   |      |                                              |   |          |       
|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|Comprehensive loss                                          |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|Balances at Dec. 31, 2006                                   |                                                  | 18,158 |   |   | 12,015 |   | 42,029,411 |   |   | 144,820 |   |   |     |                                               |   | (184,111 | )      
|Issuance of common stock, net of issuance costs             |                                                  |       |   |   |       |   | 5,300,000  |   |   | 19,966  |   |   |     |                                               |   |         |        
|Issuance of common stock upon exercise of options           |                                                  |       |   |   |       |   | 268,554    |   |   | 778     |   |   |     |                                               |   |         |        
|Issuance of common stock upon exercise of warrants          |                                                  |       |   |   |       |   | 27,988     |   |   |        |   |   |     |                                               |   |         |        
|Issuance of common stock under employee stock purchase plan |                                                  |       |   |   |       |   | 136,731    |   |   | 382     |   |   |     |                                               |   |         |        
|Issuance of common stock to employees                       |                                                  |       |   |   |       |   | 100,000    |   |   | 364     |   |   |     |                                               |   |         |        
|Issuance of common stock to consultants for services        |                                                  |       |   |   |       |   | 2,845      |   |   | 10      |   |   |     |                                               |   |         |        
|Stock-based compensation                                    |                                                  |       |   |   |       |   |           |   |   | 1,967   |   |   |     |                                               |   |         |        
|Comprehensive income:                                       |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|                                                            | Net income                                       |        |  |   |        |  |            |  |   |         |  |   |      |                                              |   |          | 49,219 
|                                                            | Unrealized gain on available-for-sale securities |        |  |   |        |  |            |  |   |         |  |   |      |                                              |   |          |       
|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|Comprehensive income                                        |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        
|Balances at Dec. 31, 2007                                   |                                                  | 18,158 |   | $ | 12,015 |   | 47,865,529 |   | $ | 168,287 |   | $ |     |                                               | $ | (134,892 | )      
|                                                            |                                                  |        |   |   |        |   |            |   |   |         |   |   |      |                                               |   |          |        

See accompanying notes to Consolidated Financial Statements.

72

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DEPOMED, INC    CONSOLIDATED STATEMENTS OF CASH FLOWS    (in thousands)

|                                                                                                   |                                                | Year Ended December 31,                        |                                                    
|-------------------------------------------------------------------------------------------------- | ---------------------------------------------- | ---------------------------------------------- | ---------------------------------------------------
|
|Operating Activities                                                                               |                                                |                                                |                                                    
|Net income (loss)                                                                                  |                                                | $                                              | 49,219                                             
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |                                                |                                                |                                                    
|                                                                                                   | Depreciation and amortization                  |                                                |                                                    
|                                                                                                   | Gain on extinguishment of debt                 |                                                |                                                    
|                                                                                                   | Accrued interest expense on shareholder notes  |                                                |                                                    
|                                                                                                   | Employee and director stock-based compensation |                                                |                                                    
|                                                                                                   | Stock-based compensation issued to consultants |                                                |                                                    
|                                                                                                   | Changes in assets and liabilities:             |                                                |                                                    
|                                                                                                   |                                                | Accounts receivable                            |                                                    
|                                                                                                   |                                                | Inventories                                    |                                                    
|                                                                                                   |                                                | Other current assets                           |                                                    
|                                                                                                   |                                                | Other assets                                   |                                                    
|                                                                                                   |                                                | Accounts payable and other accrued liabilities |                                                    
|                                                                                                   |                                                | Accrued compensation                           |                                                    
|                                                                                                   |                                                | Deferred revenue                               |                                                    
|                                                                                                   |                                                |                                                |                                                    
|                                                                                                   |                                                |                                                | Net cash provided by (used in) operating activities
|                                                                                                   |                                                |                                                |                                                    
|Investing Activities                                                                               |                                                |                                                |                                                    
|Purchase of property and equipment                                                                 |                                                |                                                | (156                                               
|Purchases of marketable securities                                                                 |                                                |                                                | (67,476                                            
|Maturities of marketable securities                                                                |                                                |                                                | 28,655                                             
|Sales of marketable securities                                                                     |                                                |                                                | 2,991                                              
|                                                                                                   |                                                |                                                |                                                    
|                                                                                                   |                                                |                                                | Net cash (used in) provided by investing activities
|                                                                                                   |                                                |                                                |                                                    
|Financing Activities                                                                               |                                                |                                                |                                                    
|Payments on capital lease obligations                                                              |                                                |                                                |                                                   
|Payments on equipment loans                                                                        |                                                |                                                |                                                   
|Payment of promissory note from related party                                                      |                                                |                                                |                                                   
|Proceeds from issuance of common stock                                                             |                                                |                                                | 21,125                                             
|                                                                                                   |                                                |                                                |                                                    
|                                                                                                   |                                                |                                                | Net cash provided by financing activities          
|                                                                                                   |                                                |                                                |                                                    
|Net (decrease) increase in cash and cash equivalents                                               |                                                |                                                | (200                                               
|Cash and cash equivalents at beginning of year                                                     |                                                |                                                | 14,574                                             
|                                                                                                   |                                                |                                                |                                                    
|Cash and cash equivalents at end of year                                                           |                                                | $                                              | 14,374                                             
|                                                                                                   |                                                |                                                |                                                    
|Supplemental Disclosure of Cash Flow Information                                                   |                                                |                                                |                                                    
|Cash paid during the period for:                                                                   |                                                |                                                |                                                    
|                                                                                                   | Interest                                       |                                                | $                                                  
|                                                                                                   |                                                |                                                |                                                    
|                                                                                                   | Taxes                                          |                                                |                                                    
|                                                                                                   |                                                |                                                |                                                    

See
accompanying notes to Consolidated Financial Statements.

73

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DEPOMED, INC.        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Depomed is a specialty pharmaceutical company focused on the development and commercialization of differentiated products that address large and growing markets
and are based on proprietary oral drug delivery technologies. The Company has developed two commercial products. GLUMETZA (metformin hydrochloride extended release tablets) is a
once-daily treatment for adults with type 2 diabetes that the Company markets in the United States. ProQuin XR (ciprofloxacin hydrochloride extended release tablets) is a
once-daily treatment for uncomplicated urinary tract infections that the Company jointly commercializes in the United States with Watson Pharmaceuticals (Watson). The Company has a product
candidate, Gabapentin GR, an extended release form of gabapentin, currently in a Phase 3 trial for the treatment of postherpetic neuralgia. The Company has also completed a
Phase 2 trial for Gabapentin GR for the treatment of menopausal hot flashes and a Phase 2 trial for Gabapentin GR for the treatment of diabetic peripheral neuralgia

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and Depomed Development, Ltd. (DDL) through April 2007, at which time DDL was
dissolved. DDL did not have any fixed assets, liabilities or employees and will not perform any further product development on behalf of Depomed or any other entity. Material intercompany accounts and
transactions have been eliminated.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Revenue Recognition

The Company recognizes revenue from the sale of its products, royalties earned and contract arrangements. Revenue arrangements with multiple elements are divided
into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the
fair value of the undelivered items. The consideration received is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are applied
to each of the separate units.

Revenue
is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred and title has passed, the price is fixed or determinable and the Company is
reasonably assured of collecting the resulting receivable.



74

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





75

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Stock-Based Compensation

Effective January 1, 2006, Depomed implemented the provisions of Statement of Financial Accounting Standards (FAS) No. 123 (revised 2004), Share-Based
Payment(FAS 123(R)), as interpreted by SEC Staff Accounting Bulletin No. 107 (SAB 107), using the modified prospective
transition method. FAS 123(R) is a revision of Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based
Compensation(FAS 123), and supercedes APB Opinion No. 25,Accounting for Stock Issued to Employees(APB
No. 25). FAS 123(R) requires companies to recognize the cost of employee and director services received in exchange for awards of equity instruments, based on the grant-date
fair value of those awards, in the statement of operations. Using the modified prospective transition method of FAS 123(R), Depomed began recognizing fair-value compensation expense
for stock-based awards, including stock options granted and purchase rights issued under its employee purchase plan after January 1, 2006. Compensation expense for

76

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

stock-based
awards granted prior to implementation that were unvested and outstanding as of January 1, 2006 is recognized over the requisite service period based on the grant-date
fair value of those options and awards as previously calculated under FAS 123. The compensation expense for stock-based compensation is based on the single-option approach, includes an estimate
for forfeitures and is recognized over the vesting term of the options using the straight-line method. FAS 123(R) requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Depomed estimates forfeitures based on historical experience. Under the modified prospective transition
method of implementation, no restatement of prior periods has been made. See Note 8 of the Notes to Consolidated Financial Statements for further information regarding Depomed's stock-based
compensation expense.

Research and Development Expense and Accruals

Research and development expenses include related salaries, contractor fees, clinical trial costs, facilities costs, administrative expenses and allocations of
corporate costs. All such costs are charged to research and development expense as incurred. These expenses result from the Company's independent research and development efforts as well as efforts
associated with collaborations. The Company reviews and accrues clinical trial expenses based on work performed, which relies on estimates of total costs incurred based on patient enrollment,
completion of patient studies and other events. The Company follows this method since reasonably dependable estimates of the costs applicable to various stages of a research agreement or clinical
trial can be made. Accrued clinical costs are subject to revisions as trials progress to completion. Revisions are charged to expense in the period in which the facts that give rise to the revision
become known.

Shipping and Handling Costs

Shipping and handling costs incurred for inventory purchases and product shipments are recorded in cost of sales in the consolidated statements of operations.

Advertising Costs

Costs associated with advertising are expensed on first showing. Advertising expense for the years ended December 31, 2007 and 2006 were
$2.2 million and $1.3 million, respectively. There was no advertising expense for the year ended December 31, 2005. At December 31, 2007, the Company had approximately
$0.4 million in prepaid samples classified within prepaid expenses and other current assets.

Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes certain changes in
equity of the Company that are excluded from net loss. Specifically, FAS No. 130,Reporting Comprehensive Income, requires unrealized holding
gains and losses on the Company's available-for-sale securities, which were reported separately in shareholders' equity, to be included in accumulated other comprehensive
income (loss). Comprehensive income (loss) for the years ended December 31, 2007, 2006 and 2005 has been reflected in the Consolidated Statements of Shareholders' Equity (Deficit).

77

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Cash, Cash Equivalents and Marketable Securities

The Company considers all highly liquid investments with an original maturity (at date of purchase) of three months or less to be cash equivalents. Cash and cash
equivalents consist of cash on deposit with banks, money market instruments and commercial paper. The Company places its cash, cash equivalents and marketable securities with high quality, U.S.
financial institutions and, to date, has not experienced material losses on any of its balances. The Company records cash and cash equivalents at amortized cost, which approximates the fair value. All
marketable securities are classified as available-for-sale since these instruments are readily marketable. These securities are carried at fair value, which is based on readily
available market information, with unrealized gains and losses included in accumulated other comprehensive income (loss) within shareholders' equity. The Company uses the specific identification
method to determine the amount of realized gains or losses on sales of marketable securities. We regularly review all of our investments for other-than-temporary declines in
fair value. Our review includes the consideration of the cause of the impairment including the creditworthiness of the security issuers, the number of securities in an unrealized loss position, as
well as the severity and duration of the unrealized losses. When we determine that the decline in fair value of an investment is below our accounting basis and this decline is
other-than-temporary, we reduce the carrying value of the security we hold and record a loss in the amount of such decline. Realized gains or losses have been insignificant and
are included in "interest and other income" in the consolidated statement of operations.

Accounts Receivable

Trade accounts receivable are recorded net of allowances for cash discounts for prompt payment. To date the Company has not recorded a bad debt allowance due to
the fact that the majority of its product revenue comes from sales to a limited number of financially sound companies. The need for bad debt allowance is evaluated each reporting period based on our
assessment of the credit worthiness of our customers.

Inventories

Inventories are stated at the lower of cost or market with cost determined by specific manufactured lot. Inventories consist of costs of the active pharmaceutical
ingredient, contract manufacturing and packaging costs. The Company writes-off the value of inventory for potentially excess, dated or obsolete inventories based on an analysis of
inventory on hand and on firm purchase commitments.

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation and amortization (See Note 5 of the Notes to Consolidated Financial Statements).
Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, as follows:

Furniture and office equipment

3-5 yearsLaboratory equipment

3-5 yearsLeasehold improvements

Shorter of estimated useful life or lease term


78

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Impairment of Long-Lived Assets

In accordance with FAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets,
the Company identifies and records impairment losses, as circumstances dictate, on long-lived assets used in operations when events and circumstances indicate that the assets might be
impaired and the discounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. If the undiscounted future cash flows are less than the carrying
amount of the asset, an impairment loss, measured as the excess of the carrying value of the asset over its estimated fair value, will be recognized. The cash flow estimates used in such calculations
are based on management's best estimates, using appropriate and customary assumptions and projections at the time. No such impairments have been identified with respect to the Company's
long-lived assets, which consist primarily of property and equipment.

Net Income (Loss) Per Common Share

Basic net income (loss) per common share is calculated based on the weighted-average number of shares of our common stock outstanding during the period. Diluted
net income (loss) per common share is calculated based on the weighted-average number of shares of our common stock outstanding and other dilutive securities outstanding during the period. The
potential dilutive shares of our common stock resulting from the assumed exercise of outstanding stock options and equivalents and the assumed exercise of the warrants are determined under the
treasury stock method. Shares used in the computation on net income (loss) per common share are as follows:

2007

2006

2005Weighted-average sharesbasic

45,951,127

41,517,611

39,821,182Effect of dilutive securities:Stock options

246,334



Warrants

155,746



Weighted-average sharesdiluted

46,353,207

41,517,611

39,821,182


For
the years ended December 31, 2007, 2006 and 2005, 7.0 million, 8.4 million and 8.9 million common stock equivalents are not included in dilutive shares
because their effect is anti-dilutive.

Income Taxes

Income taxes are computed in accordance with FAS No. 109,Accounting for Income Taxes(FAS 109),
which requires the use of the liability method in accounting for income taxes. Under FAS 109, deferred tax assets and liabilities are measured based on differences between the financial
reporting and tax basis of assets and liabilities using enacted rates and laws that are expected to be in effect when the differences are expected to reverse.

On
January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48,Accounting for
Uncertainty in Income Taxesan interpretation of FASB Statement No. 10(FIN 48). Implementation of FIN 48 did not result in a cumulative
adjustment to retained earnings (accumulated deficit). The total amount of unrecognized tax benefits as of the date of adoption was $2.3 million. See Note 12 of the Notes to the
Consolidated Financial Statements for further discussion on FIN 48.

79

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Segment Information

The Company follows FAS No. 131,Disclosures about Segments of an Enterprise and Related Information, which
establishes standards for reporting financial information about operating segments in financial statements, as well as additional disclosures about products and services, geographic areas, and major
customers. The Company operates in one operating segment and has operations solely in the United States. To date, all of the Company's revenues from product sales are related to sales of GLUMETZA and
ProQuin XR in the United States. The Company has recognized license and royalty revenue from license agreements in the territories of the United States, Canada and Korea.

Concentration of Risk

The Company is subject to credit risk from its accounts receivable related to product sales. The majority of the Company's trade accounts receivable arises from
product sales in the United States. Three wholelesale distributors represented 36%, 35% and 21% of GLUMETZA and ProQuin XR shipments for the year ended December 31, 2007. These three customers
individually comprised 38%, 46% and 11%, respectively, of GLUMETZA and ProQuin XR accounts receivable as of December 31,
2007. To date, the Company has not experienced any losses with respect to the collection of its accounts receivable and believes that all of its past due accounts receivable are collectible.

The
Company relies on a single third-party manufacturer in Puerto Rico to manufacture GLUMETZA and ProQuin XR. The Company also relies on two third-party suppliers for the supply of
metformin hydrochloride, the active pharmaceutical ingredient in GLUMETZA and a single third-party supplier for the supply of ciprofloxacin hydrochloride, the active pharmaceutical ingredient in
ProQuin XR.

Recently Issued Accounting Standards

In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(FAS 157), which defines
fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FAS 157 is effective for the
Company beginning January 1, 2008. The Company does not expect the adoption of FAS 157 to have a material impact on its consolidated financial statements.

In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities(FAS 159). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value. FAS 159 is effective for the Company beginning
January 1, 2008. The Company does not expect the adoption of FAS 159 to have a material impact on its consolidated financial statements.

In
December 2007, the FASB ratified the final consensuses in Emerging Issues Task Force (EITF) Issue No. 07-1,Accounting for Collaborative
Arrangements(EITF 07-1), which requires certain income statement presentation of transactions with third parties and of payments between parties of the
collaborative arrangement, along with disclosure about the nature and purpose of the arrangement. EITF 07-1 is effective for the Company beginning January 1, 2009. The
Company does not expect EITF 07-1 to have a material effect on its consolidated financial statements.

In
June 2007, the FASB ratified EITF Issue No. 07-3,"Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in
Future Research and Development Activities"

80

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(EITF 07-3).
EITF 07-3 requires that nonrefundable advance payments for goods and services that will be used or rendered in future R&D activities pursuant to
contractual arrangements be deferred and recognized as an expense in the period that the related goods are delivered or services are performed. EITF 07-3 is effective for the
Company beginning on January 1, 2008. The Company does not expect EITF 07-3 to have a material effect on its consolidated financial statements.

NOTE 2. LICENSE AND COLLABORATIVE ARRANGEMENTS

King Pharmaceuticals, Inc.

In June 2006, the Company entered into a promotion agreement with King Pharmaceuticals, Inc. (King), pursuant to which King was granted the
co-exclusive right to promote GLUMETZA in the United States. Under the agreement, King was required to promote GLUMETZA to physicians in the United States through its sales force, to
deliver a minimum number of annual detail calls to potential GLUMETZA prescribers, and to maintain a sales force of a minimum size. In consideration for King's promotion of GLUMETZA, the Company was
required to pay King a promotion fee equal to fifty percent of gross margin, which was defined in the agreement as sales of GLUMETZA, net of actual returns, estimated discounts, estimated rebates and
estimated chargebacks, minus cost of goods sold and certain adjustments, including the one percent royalty due to Biovail Laboratories International with respect to sales of the 500mg GLUMETZA tablet
in the United States. The Company recognized $3.0 million and $2.4 million in promotion fee expense for the years ended December 31, 2007 and 2006, respectively, under the
agreement, which has been classified in selling, general and administrative expense.

In
October 2007, the Company and King terminated the promotion agreement and King paid the Company $29.7 million in termination fees. As a result of the agreement termination and
related termination fee, the Company recognized a gain of $29.6 million within operating income in the fourth quarter of 2007. Beginning in the fourth quarter of 2007, the Company is no longer
obligated to pay King promotion fees on sales of GLUMETZA in the United States.

Esprit Pharma, Inc.

In July 2005, the Company entered into an exclusive license agreement with Esprit to market and distribute ProQuin XR in the United States. The agreement was
amended in July 2006. In connection with the license agreement, the Company also entered into a related supply agreement with Esprit, pursuant to which the Company supplied commercial quantities of
ProQuin XR to Esprit.

The
license agreement obligated Esprit to pay the Company $50.0 million in license fees, of which $30.0 million was paid in July 2005 and $10.0 million was paid in
December 2006. The remaining $10.0 million was due in July 2007. The license fee payments received were scheduled to be recognized as revenue ratably until June 2020, which represented the
length of time that the Company was obligated to manufacture ProQuin XR for Esprit or its licensees.

The
license agreement also provided for royalty payments by Esprit to the Company of 15 percent to 25 percent of ProQuin XR net sales, based on escalating net sales and
subject to certain minimum royalty amounts. Esprit's minimum royalty obligation for 2007 was $5.0 million, and in subsequent years was $5.0 million per year, subject to annual increases
in the consumer price index beginning in 2008.

81

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2. LICENSE AND COLLABORATIVE ARRANGEMENTS (Continued)

In
July 2007, the Company entered into a termination and assignment agreement with Esprit terminating the exclusive license agreement and related supply agreement. Upon entering into the
termination and assignment agreement, the marketing and distribution rights in the United States for ProQuin XR reverted back to the Company and Esprit paid the Company $17.5 million,
representing (i) a $10.0 million payment in respect of the final license payment that would have been due to the Company in July 2007 under the license agreement; (ii) a
$2.5 million payment in respect of a pro-rated portion of minimum royalties for 2007 under the license agreement; and (iii) a $5.0 million termination fee. Esprit has
no future royalty obligations to the Company.

As
a result of termination of the license and supply agreements with Esprit, the Company no longer has continuing obligations to Esprit. Accordingly, all deferred revenue related to
license fees previously
received from Esprit was fully recognized as revenue in July 2007, resulting in recognition of approximately $36.1 million of license revenue. In addition, the final $10.0 million
payment received in July 2007 was fully recognized as license revenue on receipt, resulting in total recognition of $46.1 million of license revenue in the third quarter of 2007. The royalty
payment of $2.5 million was recognized as royalty revenue and the $5.0 million termination fee has been classified as a gain within operating income in the third quarter of 2007.

In
total, the Company recognized $47.5 million, $2.1 million and $0.4 million of license revenue related to the recognition of these upfront fees for the years ended
December 31, 2007, 2006 and 2005, respectively. The Company recognized a total of $2.5 million, $3.9 million and $0.7 million of royalty revenue under the agreements for
the years ended December 31, 2007, 2006 and 2005, respectively. The Company recognized zero, $1.3 million and $0.9 million of product revenue related to the supply of ProQuin XR
to Esprit for the years ended December 31, 2007, 2006 and 2005, respectively.

Biovail Laboratories International

GLUMETZA

In May 2002, the Company entered into a development and license agreement granting Biovail Laboratories Incorporated (Biovail) an exclusive license in the United
States and Canada to manufacture and market GLUMETZA. Under the terms of the agreement, the Company was responsible for completing the clinical development program in support of the 500mg GLUMETZA. In
April 2003, Biovail submitted a New Drug Application to the U.S. Food and Drug Administration (FDA) for approval and in July 2005, Biovail received FDA approval to market GLUMETZA in the United
States. In accordance with the license agreement, Biovail paid a $25.0 million license fee payment to the Company.

In
April 2004, the Company and Biovail amended the GLUMETZA license agreement. Under the amended agreement, the Company would receive royalties on sales of Biovail's 1000mg metformin HCl
tablet in the United States and Canada in exchange for allowing Biovail to use the Company's clinical data for its Metformin GR, a 500mg metformin HCl tablet, to support and accelerate regulatory
submissions for Biovail's 1000mg tablet and to establish equivalence between the two dosage forms. In May 2005, Biovail received a Notice of Compliance for the 500mg and 1000mg strengths of GLUMETZA
from the Therapeutic Products Directorate of Canada to market the products in Canada.

In
October 2005, the Company delivered a notice of breach to Biovail and subsequently filed suit in respect of its license agreement with Biovail, related to the failure of Biovail to
make the first

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2. LICENSE AND COLLABORATIVE ARRANGEMENTS (Continued)

commercial
sale of the 500mg strength GLUMETZA within 120 days of approval in each of Canada and the United States as required in the license agreement. In December 2005, the Company settled
its dispute with Biovail and entered into an amended license agreement whereby the Company granted to Biovail an exclusive license in Canada to manufacture and market the 500mg formulation of GLUMETZA
and the Company established its right to manufacture and market the 500mg GLUMETZA in the United States and internationally with the exception of Canada. The Company will recognize the
$25.0 million license fee payment as revenue ratably until February 2023, which represents the estimated length of time the Company's obligations exist under the arrangement related to
royalties it is obligated to pay Biovail on net sales of the 500mg GLUMETZA in the United States and to use Biovail as the Company's sole supplier of the 1000mg GLUMETZA. The Company recognized
$1.5 million, $1.5 million, and $0.1 million of license revenue related to the amortization of this upfront fee for the years ended December 31, 2007, 2006 and 2005,
respectively.

Under
the agreement, Biovail is obligated to pay the Company royalties of six percent on Canadian net sales of the 500mg GLUMETZA and one percent on Canadian net sales of the 1000mg
GLUMETZA. In July 2007, the royalty percentage increased to ten percent on Canadian net sales of the 500mg GLUMETZA, and returned to six percent in January 2008, on FDA approval of the 1000mg
formulation of GLUMETZA in the United States. The Company recognized royalty revenue under the agreement of $0.2 million, $0.1 million and zero for the years ended December 31,
2007, 2006 and 2005, respectively.

The
Company is obligated to pay Biovail royalties of one percent on net sales of the 500mg GLUMETZA in the United States. The Company recognized royalty expense under the agreement of
$0.1 million, $0.1 million and zero for the years ended December 31, 2007, 2006 and 2005, respectively.

As
part of the same settlement, Biovail granted the Company an exclusive license to market the 1000mg GLUMETZA in the United States. The Company is obligated to purchase the 1000mg
GLUMETZA exclusively from Biovail, subject to back-up manufacturing rights in the Company's favor. If the Company exercises its back-up rights, compensation to Biovail will
change from a supply-based arrangement to royalties of six percent on net sales of the 1000mg GLUMETZA.

Technology License

In February 2007, the Company entered into a license and development agreement with Biovail granting Biovail an option to license the AcuForm drug delivery
technology to develop and commercialize up to two pharmaceutical products. Pursuant to the agreement, Biovail paid the
Company an upfront fee of $0.5 million in February 2007, and is contingently obligated to pay the Company additional fees related to the exercise of the license option, the initiation of the
first Phase 3 trial for each product and upon receipt of U.S. regulatory approval for each product. The agreement also requires that Biovail make royalty payments to the Company on net
commercial sales of any product developed under the agreement. As the Company has no continuing obligations to Biovail under the agreement that are other than inconsequential or perfunctory, the
$0.5 million upfront license fee was recognized as license revenue in the first quarter of 2007.

Also
in February 2007, the Company amended its stock purchase agreement with Biovail originally entered into in May 2002. The amended stock purchase agreement removed Biovail's observer
rights at the Company's board of directors meetings and removed the right of first negotiation in favor of Biovail with respect to acquisition transactions involving the Company.

83

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2. LICENSE AND COLLABORATIVE ARRANGEMENTS (Continued)

LG Life Sciences, Ltd.

In August 2004, the Company entered into a license and distribution agreement granting LG Life Sciences (LG) an exclusive license to LG's version of the 500mg
GLUMETZA in the Republic of Korea. LG launched the product in Korea, known as Novamet GR (extended release metformin tablets) in 2006.

Upon
signing of the agreement, LG paid the Company a $0.6 million upfront license fee. In November 2006, both parties amended the agreement and LG paid the Company a
$0.5 million milestone payment in respect of LG's approval to market GLUMETZA in the Republic of Korea. Through December 31, 2006, the upfront license fee and milestone payment were
initially deferred and were being amortized over a period of eight years, which represented the estimated length of time the Company was obligated to provide assistance in development and
manufacturing.

In
January 2007, the Company and LG Life Sciences further amended the parties' license and distribution agreement and the Company granted LG a license to certain of the Company's
intellectual property rights to manufacture Novamet GR in exchange for royalties on net sales of Novamet GR in Korea, and to remove the provisions of the original agreement providing for the supply of
500mg Novamet GR tablets by the Company to LG. Under the amended agreement, the Company no longer has continuing performance obligations to LG that are other than inconsequential or perfunctory and
accordingly, the remaining $0.9 million of previously deferred revenue was recognized as license revenue in the first quarter of 2007.

The
Company recognized $0.9 million, $0.1 million and $0.1 million of license revenue related to the agreements for the years for the years ended December 31,
2007, 2006 and 2005, respectively.

Watson Pharmaceuticals, Inc.

In July 2007, the Company entered into a promotion agreement with Watson granting Watson a co-exclusive right to promote ProQuin XR to the urology
specialty and to long-term care facilities in the United States. In September 2007, the agreement was amended to also grant Watson a co-exclusive right to promote ProQuin XR to
the obstetrics/gynecology (ob/gyn) specialty. Watson is required to deliver a minimum number of annual sales detail calls and maintain a sales force of a minimum size. Watson will receive a promotion
fee equal to an agreed upon portion of gross margin attributable to the urology and ob/gyn specialties and long-term care facilities above an agreed upon baseline level. The Company is
responsible for the manufacture and distribution of ProQuin XR. Each party bears all of its own personnel and other costs, including marketing expenses. The term of the promotion agreement is three
years, with up to two additional one-year renewal periods at the election of Watson, and subject to early termination under certain circumstances. The Company has retained the right to
promote ProQuin XR to physicians outside the urology, ob/gyn and long-term care markets, either directly or through third parties. The Company re-launched ProQuin XR and Watson
commenced promotion in October 2007. The Company recognized no promotion fee expense under the agreement for the year ended December 31, 2007.

Madaus S.r.l./Rottapharm

In November 2005, the Company entered into a distribution and supply agreement for ProQuin XR in Europe with a privately owned specialty pharmaceutical company,
Madaus S.r.l. Under the terms

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2. LICENSE AND COLLABORATIVE ARRANGEMENTS (Continued)

of
the agreement, the Company granted an exclusive right to Madaus for the commercialization of ProQuin XR in Europe and agreed to supply Madaus with commercial quantities of ProQuin XR tablets in
bulk form. Madaus will pay the Company at a pre-specified percent of Madaus' wholesale ex-factory price, net of packaging costs. In January 2006, Madaus paid the Company a
$0.2 million license fee. An advance payment against future product sales of $0.3 million will be due within 30 days of the first European regulatory approval. In March 2006,
Madaus filed a Marketing Authorization Application (MAA) for ProQuin XR with the Medical Products Agency in Sweden, which is currently pending. No revenue has been recognized under the agreement.

PharmaNova, Inc.

In October 2006, Depomed entered into a sublicense agreement with PharmaNova, Inc. Pursuant to the agreement, PharmaNova has granted the Company an
exclusive sublicense, under a United States patent held by the University of Rochester, to develop and commercialize a product in the United States containing the compound gabapentin as its active
pharmaceutical ingredient which is indicated for the treatment of hot flashes associated with menopause in women.

The
Company paid PharmaNova an upfront license fee of $0.5 million upon signing of the agreement and is required to pay PharmaNova an additional $0.5 million upon dosing of
the first patient in any Phase 3 trial for the product, $1.0 million upon submission to the FDA of a New Drug Application for the product, and $2.0 million upon FDA approval of an
NDA. The agreement also provides for royalty payments to PharmaNova on net sales of the product, and for milestone payments upon achievement of annual net sales in excess of certain thresholds. The
Company was also required to pay PharmaNova consultancy fees of $0.3 million over a ten month period beginning in November 2006. The Company has recognized $0.2 million and
$0.6 million of research and development expense under the agreement for the years ended December 31, 2007 and 2006, respectively. The $0.5 million upfront license fee paid upon
signing of the agreement was recognized as research and development expense in 2006.

Patheon, Inc.

In August 2006, Depomed entered into a collaboration agreement with Patheon, Inc. related to the Company's proprietary AcuForm drug delivery technology.
Under the agreement, Depomed granted Patheon access to the Company's AcuForm drug delivery technology for the purpose of formulating, developing and improving pharmaceutical products outside of our
own internal programs for Patheon's clients and collaborative partners. A joint committee with representatives from Depomed and Patheon will review compounds prior to initiating work to ensure there
are no conflicts with our own internal programs. Patheon will assume primary responsibility for initial feasibility work with technical assistance from us. For product candidates that advance beyond
feasibility, Depomed, Patheon and any third party will negotiate a license agreement, and Depomed and Patheon would share any license fees, milestone payments and royalties.

Supernus Pharmaceuticals, Inc.

In September 2006, Depomed entered into a collaboration agreement with Supernus Pharmaceuticals, Inc. to develop through a Phase 1 study a product
candidate leveraging the Company's AcuForm drug delivery technology. The cost and ownership of the program will be shared

85

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2. LICENSE AND COLLABORATIVE ARRANGEMENTS (Continued)

between
the parties equally. The collaboration agreement includes provisions pursuant to which the parties may negotiate and enter into a definitive agreement for the further development and for
commercialization, by either or both parties, of the product candidate. The Company recognized $0.7 million and $0.1 million of research and development expense under the agreement for
the years ended December 31, 2007 and 2006, respectively.

Boehringer Ingelheim Pharmaceuticals, Inc.

In April 2005, Depomed entered into an agreement with Boehringer Ingelheim Pharmaceuticals, Inc. to conduct feasibility studies with an undisclosed
pharmaceutical compound and in December 2005, the Company completed the studies and delivered the agreed feasibility results. Under the agreement, all research and development work with the partner's
pharmaceutical compound was funded by the partner. The Company recognized collaborative revenue of $2.2 million in 2005, which approximated the costs recognized under the agreement.

NOTE 3. MARKETABLE SECURITIES

Securities classified as available-for-sale as of December 31, 2007 and 2006 are summarized below (in thousands). Estimated fair
value is based on quoted market prices for these investments.

|December 31, 2007        |                                                                             | Amortized
Cost                     |        | Gross
Unrealized
Gains |        | Gross
Unrealized
Losses |   | Fair Value
|------------------------ | --------------------------------------------------------------------------- | ---------------------------------- | ------ | ---------------------- | ------ | ----------------------- | - | ----------
|U.S. debt securities:    |                                                                             |                                    |        |                        |        |                         |   |           
|                         | Total included in cash and cash equivalents                                 |                                    | $      | 12,537                 |        | $                       |  |           
|                         | Total maturing within 1 year and included in marketable securities:         |                                    |        |                        |        |                         |   |           
|                         |                                                                             | U.S. corporate debt securities     |        |                        | 35,060 |                         |   | 36        
|                         |                                                                             | U.S. government debt securities    |        |                        | 3,977  |                         |   | 19        
|                         | Total maturing between 1 and 2 years and included in marketable securities: |                                    |        |                        |        |                         |   |           
|                         |                                                                             | U.S. corporate debt securities     |        |                        | 11,502 |                         |   | 39        
|                         |                                                                             | U.S. government debt securities es |        |                        | 4,500  |                         |   | 18        
|                         |                                                                             |                                    |        |                        |        |                         |   |           
|Total available-for-sale |                                                                             | $                                  | 67,576 |                        | $      | 112                     |   | $         
|                         |                                                                             |                                    |        |                        |        |                         |   |           

86

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3. MARKETABLE SECURITIES (Continued)

|
|

|December 31, 2006        |                                                                             | Amortized
Cost |                                 | Gross
Unrealized
Gains |   | Gross
Unrealized
Losses |   | Fair Value
|------------------------ | --------------------------------------------------------------------------- | -------------- | ------------------------------- | ---------------------- | - | ----------------------- | - | ----------
|U.S. debt securities:    |                                                                             |                |                                 |                        |   |                         |   |           
|                         | Total included in cash and cash equivalents                                 |                | $                               | 11,399                 |   | $                       |  |           
|                         | Total maturing within 1 year and included in marketable securities:         |                |                                 |                        |   |                         |   |           
|                         |                                                                             |                | U.S. corporate debt securities  |                        |   | 9,213                   |   |           
|                         |                                                                             |                | U.S. government debt securities |                        |   | 6,790                   |   |           
|                         | Total maturing between 1 and 2 years and included in marketable securities: |                |                                 |                        |   |                         |   |           
|                         |                                                                             |                | U.S. corporate debt securities  |                        |   | 2,994                   |   |           
|                         |                                                                             |                |                                 |                        |   |                         |   |           
|Total available-for-sale |                                                                             | $              | 30,396                          |                        | $ | 1                       |   | $         
|                         |                                                                             |                |                                 |                        |   |                         |   |           

At
December 31, 2007, the Company had six securities in an unrealized loss position.

The
following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at
December 31, 2007 (in thousands):

|                                |  | Less than 12 months |       | 12 months or greater |   | Total |  
|------------------------------- |  | ------------------- | ----- | -------------------- | - | ----- | -
|
|U.S. corporate debt securities  |  | $                   | 9,203 |                      | $ | (2    | )
|U.S. government debt securities |  |                     |      |                      |   |      |  
|                                |  |                     |       |                      |   |       |  
|Total available-for-sale        |  | $                   | 9,203 |                      | $ | (2    | )
|                                |  |                     |       |                      |   |       |  

The
gross unrealized losses above were caused by interest rate increases. No significant facts or circumstances have arisen to indicate that there has been any deterioration in the
creditworthiness of the issuers of the Company's securities. Based on the Company's review of these securities, including the assessment of the duration and severity of the related unrealized losses
and the Company's ability and intent to hold the investments until maturity, there were no other-than-temporary impairments for these securities as of December 31, 2007.

87

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 4. INVENTORIES

Inventories relate to the manufacture of the Company's GLUMETZA and ProQuin XR products. Inventories are stated at the lower of cost or market and consist of the
following (in thousands):

December 31, 2007

December 31, 2006Raw materials

$
837

$
1,343Work-in-process


419


1,387Finished goods


1,184


970Deferred costs


823


783Total

$
3,263

$
4,483


Deferred
costs represent the costs of product shipped for which recognition of revenue has been deferred.

NOTE 5. PROPERTY AND EQUIPMENT

Property and equipment consists of the following (in thousands):

December 31, 2007

December 31, 2006Furniture and office equipment

$
1,430

$
1,442Laboratory equipment


4,388


4,400Leasehold improvements


2,973


2,9198,791


8,761Less accumulated depreciation


(7,170
)

(6,220
)Property and equipment, net

$
1,621

$
2,541


There
was no property and equipment included under capitalized leases as of December 31, 2007 and December 31, 2006. Depreciation expense was $1.1 million,
$1.3 million and $1.5 million for the years ended December 31, 2007, 2006 and 2005.

NOTE 6. DEFERRED REVENUE

Deferred revenue consists of the following (in thousands):

December 31, 2007

December 31, 2006Deferred revenue, current portionDeferred product sales

$
6,489

$
4,825Deferred license revenue


1,453


4,6007,942


9,425Deferred license revenue, non-current portion


20,763


57,483Total deferred revenue

$
28,705

$
66,908


Deferred
product sales as of December 31, 2007 and December 31, 2006 relate to the Company's GLUMETZA and ProQuin XR product shipments that have not been recognized as
revenue in accordance with the Company's revenue recognition policy.

88

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6. DEFERRED REVENUE (Continued)

Deferred
license revenue relates to upfront payments received by the Company under license and marketing agreements with its partners. At December 31, 2007, deferred license
revenue consisted primarily of upfront license fee payments received from Biovail. In December 2004, the Company received a $25.0 million license fee payment under its agreement with Biovail.
The $25.0 million license fee is being recognized as revenue ratably until February 2023, which represents the estimated length of time the Company's obligations exist under the arrangement
related to royalties it is obligated to pay Biovail on net sales of GLUMETZA in the United States and to use Biovail as the Company's sole supplier of the 1000mg of GLUMETZA, should the 1000mg obtain
approval in the United States.

At
December 31, 2006, deferred license revenue consisted primarily of upfront license fee payment from Biovail and Esprit. In July 2005, the Company received $30.0 million
from Esprit and additional $10.0 million in December 2006. The license fees payments received from Esprit were recognized as
revenue ratably until June 2020, which represented the length of time that the Company was obligated to manufacture ProQuin XR for Esprit or its licensees. In July 2007, the agreements with Esprit
were terminated and the related remaining deferred license revenue was immediately recognized (See Note 2).

NOTE 7. COMMITMENTS AND CONTINGENCIES

Leases

The Company leases its facilities under non-cancelable operating leases that expire in June 2009 with options to extend the lease terms for an
additional five years. The leases are subject to annual increases on the anniversary of the commencement dates. Rent expense was $1.2 million, $1.2 million and $1.1 million years
ended December 31, 2007 2006 and 2005 respectively.

In
2004, the Company received a leasehold improvement allowance from the landlord of approximately $0.4 million which was used to reimburse costs of remodeling the Company's
facility. The Company recorded the costs of improvements in property, plant and equipment and the allowance as a deferred rent credit. The Company amortizes the leasehold improvement asset over the
shorter of the life of the improvements or the life of the lease. The Company amortizes the deferred rent credit as a reduction of rent expense on a straight-line basis over the life of
the lease.

As
of December 31, 2007 future minimum payments under operating leases for facilities and equipment were as follows (in thousands):

2008

$
1,4412009


8052010


402011


6$
2,292


Manufacturing Agreements

The Company has entered into a manufacturing arrangement with MOVA Pharmaceuticals (MOVA), a subsidiary of Patheon, Inc. pursuant to which MOVA will
manufacture commercial quantities of GLUMETZA for the Company. As of December 31, 2007 the Company has

89

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7. COMMITMENTS AND CONTINGENCIES (Continued)

non-cancelable
purchase orders and minimum purchase obligations for 2008 totaling approximately $0.7 million under this arrangement.

Convertible Promissory Note

In connection with the formation of DDL, Elan made a loan facility available to the Company for up to $8,010,000 in principal to support the Company's 80.1% share
of the joint venture's research and development costs pursuant to a convertible promissory note issued by the Company to Elan. The funding term of the loan expired in November 2002. The note had a
six-year term, was due in January 2006, and bore interest at 9% per annum, compounded semi-annually, on any amounts borrowed under the facility. However, in June 2005, the
Company repurchased the promissory note with an outstanding balance of $10.7 million, including $2.9 million of accrued interest, for $9.7 million including commissions paid to a
financial consultant and legal fees. A gain on the extinguishment of the debt of $1.1 million was recorded in other income for the year ended December 31, 2005.

Long-Term Debt

In March 2001, the Company entered into a secured equipment financing credit facility. The credit facility allowed the Company to finance up to
$2.0 million of equipment and leasehold improvements purchased from August 2000 through December 31, 2001. The interest rate was recalculated with each draw at 7.5% above the then
current 36 month US Treasury Note rate. At the end of December 2001, the Company had utilized approximately $1.3 million of the credit facility. All amounts outstanding were repaid by
July 2005 and the Company recognized $0.5 million in interest expense during the year ended December 31, 2005. The unused portion of the credit facility of $0.7 million expired on
December 31, 2001.

NOTE 8. STOCK-BASED COMPENSATION

The Company adopted FAS 123(R) on January 1, 2006 as described in Note 1 of the Notes to Consolidated Financial Statements. The Company uses
the Black-Scholes option valuation model to determine the fair value of stock options and employee stock purchase plan (ESPP) shares. The determination of the fair value of stock-based payment awards
on the date of grant using an option valuation model is affected by the Company's stock price as well as assumptions which include the Company's expected term of the award, the expected stock price
volatility, risk-free interest rate and expected dividends over the expected term of the award.

The
Company has concluded that its historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term and therefore, as of
January 1, 2006, estimates the expected term of options granted by taking the average of the vesting term and the contractual term of the option, as illustrated in SAB 107. The Company
estimates the volatility of its common stock price by using the historical volatility over the expected term of the options. The Company bases the risk-free interest rate on U.S. Treasury
zero-coupon issues with terms similar to the expected term of the options as of the date of grant. The Company does not anticipate paying any cash dividends in the foreseeable future and
therefore uses an expected dividend yield of zero in the option valuation model.

90

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8. STOCK-BASED COMPENSATION (Continued)

The
Company used the following assumptions to calculate the fair value of option grants for the years ended December 31, 2007 and 2006:

2007

2006Employee and Director Stock OptionsRisk-free interest rate

3.42-5.09
%
4.44-5.23
%Dividend yield

None

NoneExpected option term (in years)

5.25-6.06

5.25-6.06Expected stock price volatility

53.2-63.9
%
53.8-62.2
%


The Company used the following assumptions to calculate the fair value of purchase rights granted under the ESPP for the years ended December 31, 2007 and 2006:

2007

2006Employee Stock Purchase PlanRisk-free interest rate

2.90-4.98
%
4.52-5.06
%Dividend yield

None

NoneExpected option term (in years)

0.5-2.0

0.5-2.0Expected stock price volatility

59.6-83.6
%
33.5-56.1
%


The
following table presents stock-based compensation expense recognized under FAS 123(R) for stock options, stock awards and the Company's employee stock purchase program (ESPP)
in the Company's consolidated statements of operations (in thousands):

2007

2006Cost of sales

$
24

$
12Research and development expense


695


976Selling, general and administrative expense


1,622


1,584Total

$
2,341

$
2,572


The
weighted-average grant date fair value of options granted during the years ended December 31, 2007 and 2006 were $1.62 and $3.50, respectively. The weighted-average grant date
fair value of purchase rights granted under the ESPP during the years ended December 31, 2007 and 2006 were $1.57 and $1.55, respectively. The total intrinsic value of options exercised during
the years ended December 31, 2007 and 2006 were $0.2 million was $0.5 million, respectively. The total fair value of options that vested during the years ended December 31,
2007 and 2006 were $1.6 million and $2.3 million, respectively. At December 31, 2007, Depomed had $5.6 million of total unrecognized compensation expense, net of estimated
forfeitures, related to stock option plans that will be recognized over an average vesting period of 2.5 years. Cash received from stock option exercises was $0.8 million and
$0.5 million for the years ended December 31, 2007 and 2006.

Prior
to January 1, 2006, the Company measured compensation expense for its employee stock-based compensation plans using the intrinsic value method under APB No. 25. Under
APB No. 25, no stock-based compensation was recognized for the ESPP or for option grants when the exercise price of the options granted was equal to or greater than the fair value market price
of the stock on the grant date. In accordance with the provisions of FAS 123(R), we eliminated the balance of the deferred

91

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8. STOCK-BASED COMPENSATION (Continued)

compensation
calculated under APB No. 25 to the common stock account on January 1, 2006. For the year ended December 31, 2005, the Company recognized approximately
$0.4 million, respectively, of stock-based compensation expense under APB No. 25.

Pro Forma Information under FAS 123 for Periods Prior to Fiscal 2006

Prior to January 1, 2006, Depomed followed the disclosure provisions of FAS 123. The following table illustrates the effect on net loss (in
thousands) and net loss per share for the year ended December 31, 2005 if the fair value recognition provisions of FAS 123 had been applied to options granted and ESPP shares purchased
under Depomed's equity-based compensation plans. For purposes of this pro forma disclosure, the estimated value of the awards is recognized over the vesting periods.

2005Net loss applicable to common stock shareholdersas reported

$
(25,309
)Add: Total stock-based employee and director compensation expense, included in the determination of net loss as reported


386Deduct: Total stock-based employee and director compensation expense determined under the fair value based method for all awards


(2,123
)Net loss applicable to common stock shareholderspro forma

$
(27,046
)Net loss per common shareas reported

$
(0.64
)Net loss per common sharepro forma

$
(0.68
)


For
purposes of the weighted-average estimated fair value calculations, the fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option
valuation model and the following assumptions:

2005Employee and Director Stock OptionsRisk-free interest rate

3.85-4.43%Dividend yield

NoneExpected option term (in years)

4.0Expected stock price volatility

65.2-67.0%


Based
on the Black-Scholes option valuation model, the weighted-average estimated fair value of options granted was $2.66 for the year ended December 31, 2005. The total intrinsic
value of options exercised during the years ended December 31, 2005 was $0.6 million. The total fair value of options vested was $2.0 million for the year ended
December 31, 2005.

92

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8. STOCK-BASED COMPENSATION (Continued)

The
Company used the following assumptions to calculate the fair value of purchase rights granted under the ESPP for the year ended December 31, 2005.

2005Employee Stock Purchase PlanRisk-free interest rate

3.22-4.33%Dividend yield

NoneExpected option term (in years)

0.5Expected stock price volatility

43.3-47.0%


Based
on the Black-Scholes option valuation model, the weighted-average estimated fair value of purchase rights granted under the ESPP was $1.75 for the year ended December 31,
2005.

1995 Stock Option Plan

The Company's 1995 Stock Option Plan (the 1995 Plan) was adopted by the Board of Directors and approved by the shareholders in September 1995, and has been
subsequently amended. The 1995 Plan provided for the grant to employees of the Company, including officers, of incentive stock options, and for the grant of nonstatutory stock options to employees,
directors and consultants of the Company. The number of shares authorized under the 1995 Plan is 4,700,000 shares, of which zero are available for future issuance at December 31, 2007. In May
2004, the 1995 Plan was terminated with respect to grants of new stock options and all options which expire or are forfeited will be retired from the pool.

Generally,
the exercise price of all incentive stock options and nonstatutory stock options granted under the 1995 Plan must be at least 100% and 85%, respectively, of the fair value of
the common stock of
the Company on the grant date. The term of incentive and nonstatutory stock options may not exceed 10 years from the date of grant. An option shall be exercisable on or after each vesting date
in accordance with the terms set forth in the option agreement. The right to exercise an option generally vests over four years at the rate of at least 25% by the end of the first year and then
ratably in monthly installments over the remaining vesting period of the option.

93

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8. STOCK-BASED COMPENSATION (Continued)

The
following table summarizes the activity for the three years ended December 31, 2007 under the 1995 Plan:

Shares

Weighted-Average
Exercise PriceOptions outstanding at December 31, 2004

3,788,676

$
4.24Options exercised

(221,438
)

2.91Options forfeited

(156,744
)

6.48Options expired

(4,940
)

4.36Options outstanding at December 31, 2005

3,405,554

$
4.22Options exercised

(220,445
)

1.99Options forfeited

(92,203
)

5.80Options expired

(40,254
)

6.03Options outstanding at December 31, 2006

3,052,652

$
4.31Options exercised

(266,949
)

2.89Options forfeited

(990,316
)

5.13Options expired

(251,767
)

3.82Options outstanding at December 31, 2007

1,543,620

$
4.12Options exercisable and expected to become exercisable at December 31, 2007

1,543,619

$
4.12Options exercisable at December 31, 2007

1,543,516

$
4.12


|
|

Weighted-Average
Remaining
Contractual
Term (Years)

Aggregate
Intrinsic Value
(in thousands)Options outstanding at December 31, 2007

3.42

$
644Options exercisable and expected to become exercisable at December 31, 2007

3.42

$
644Options exercisable at December 31, 2007

3.42

$
644


94

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8. STOCK-BASED COMPENSATION (Continued)

Information regarding the stock options outstanding at December 31, 2007 under the 1995 Plan is summarized below:

|Range of Exercise Prices |  | Number
Outstanding |  | Weighted-
Average
Remaining
Contractual
Term (Years) |  | Weighted-
Average
Exercise
Price |      | Number
Exercisable |           | Weighted-
Average
Exercise
Price
|------------------------ |  | ------------------ |  | ---------------------------------------------------- |  | -------------------------------- | ---- | ------------------ | --------- | --------------------------------
|$1.71                    |  | 316,268            |  | 4.98                                                 |  | $                                | 1.71 |                    | 316,268   |                                 
|$1.95 - $3.40            |  | 333,861            |  | 2.40                                                 |  |                                  | 2.82 |                    | 333,861   |                                 
|$3.50 - $4.30            |  | 396,555            |  | 2.96                                                 |  |                                  | 4.03 |                    | 396,555   |                                 
|$4.44 - $6.76            |  | 341,946            |  | 4.55                                                 |  |                                  | 6.12 |                    | 341,946   |                                 
|$7.32 - $9.50            |  | 154,990            |  | 1.14                                                 |  |                                  | 7.61 |                    | 154,886   |                                 
|                         |  |                    |  |                                                      |  |                                  |      |                    |           |                                 
|                         |  | 1,543,620          |  | 3.42                                                 |  | $                                | 4.12 |                    | 1,543,516 |                                 
|                         |  |                    |  |                                                      |  |                                  |      |                    |           |                                 

In
December 2002, the Board of Directors authorized an increase in the number of shares authorized for issuance under the 1995 Plan by 1,306,811 shares. On May 29, 2003 at the
2003 Annual Meeting of Shareholders, the Company's shareholders approved this increase to the 1995 Plan. In December 2002 and March 2003, the Company granted options to purchase approximately 585,000
shares of common stock out of the 1,306,811 share increase at exercise prices of $1.71 and $2.70, respectively, which represented the fair market values of the Company's common stock on the respective
dates of grant. However, as the options were not deemed authorized for grant until the shareholders approved the increase in the number of shares authorized under the 1995 Plan, the applicable
measurement date for accounting purposes was on the date such approval was obtained. Since the fair market value of the underlying common stock on May 29, 2003 was $3.50, which was greater than
the exercise prices of the stock options granted, the Company was required to record the difference of approximately $1.0 million as deferred stock-based compensation expense to be recognized
ratably over the vesting period of the related stock options under APB No. 25. For the year ended December 31, 2005, the Company recognized approximately $0.2 million in
stock-based compensation expense related to these stock options.

As
described in Note 1 of the Notes to Consolidated Financial Statements, the Company adopted FAS 123(R) on January 1, 2006 under the modified prospective transition
method. In accordance with the provisions of FAS 123(R), the Company eliminated the balance of the deferred compensation calculated under APB No. 25 to the common stock account for these
options on January 1, 2006 and began recognizing expense based on the grant-date fair prospectively.

2004 Equity Incentive Plan

The Company's 2004 Equity Incentive Plan (the 2004 Plan) was adopted by the Board of Directors and approved by the shareholders in May 2004. The 2004 Plan
provides for the grant to employees of the Company, including officers, of incentive stock options, and for the grant of nonstatutory stock options to employees, directors and consultants of the
Company. The number of shares authorized under the 2004 Plan at December 31, 2007 was 5,000,000 shares, of which 1,371,753 were available for future issuance.

95

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8. STOCK-BASED COMPENSATION (Continued)

Generally,
the exercise price of all incentive stock options and nonstatutory stock options granted under the 2004 Plan must be at least 100% and 85%, respectively, of the fair value of
the common stock of the Company on the grant date. The term of incentive and nonstatutory stock options may not exceed 10 years from the date of grant. An option shall be exercisable on or
after each vesting date in accordance with the terms set forth in the option agreement. The right to exercise an option generally vests over four years at the rate of at least 25% by the end of the
first year and then ratably in monthly installments over the remaining vesting period of the option.

The
following tables summarize the activity for the three years ended December 31, 2006 under the 2004 Plan:

Shares

Weighted-
Average
Exercise
PriceOptions outstanding at December 31, 2004

557,944

$
5.25Options granted at fair market value

471,738


5.08Options exercised

(13,030
)

4.98Options forfeited

(50,242
)

5.01Options outstanding at December 31, 2005

966,410

$
5.18Options granted at fair market value

1,284,250


5.75Options exercised

(7,561
)

5.09Options forfeited

(100,156
)

6.04Options outstanding at December 31, 2006

2,142,943

$
5.49Options granted at fair market value

2,445,185


2.81Options exercised

(1,605
)

3.84Options forfeited

(1,083,359
)

4.82Options outstanding at December 31, 2007

3,503,164

$
3.82Options exercisable and expected to become exercisable at December 31, 2007

3,248,899

$
3.87Options exercisable at December 31, 2007

997,271

$
5.08


|
|

Weighted-
Average
Remaining
Contractual
Term (Years)

Aggregate
Intrinsic Value
(in thousands)Options outstanding at December 31, 2007

8.84

$
1,544Options exercisable and expected to become exercisable at December 31, 2007

8.81

$
1,390Options exercisable at December 31, 2007

7.82

$
50


96

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8. STOCK-BASED COMPENSATION (Continued)

Information
regarding the stock options outstanding at December 31, 2007 under the 2004 Plan is summarized below:

|Range of Exercise Prices |  | Number
Outstanding |  | Weighted-
Average
Remaining
Contractual
Term (Years) |  | Weighted-
Average
Exercise
Price |      | Number
Exercisable |         | Weighted-
Average
Exercise
Price
|------------------------ |  | ------------------ |  | ---------------------------------------------------- |  | -------------------------------- | ---- | ------------------ | ------- | --------------------------------
|$1.98                    |  | 1,080,300          |  | 9.65                                                 |  | $                                | 1.98 |                    | 33,333  |                                 
|$2.05 - $3.31            |  | 781,384            |  | 9.41                                                 |  |                                  | 3.08 |                    | 150,360 |                                 
|$3.38 - $5.08            |  | 823,193            |  | 8.13                                                 |  |                                  | 4.54 |                    | 377,807 |                                 
|$5.73 - $6.29            |  | 798,500            |  | 7.99                                                 |  |                                  | 6.22 |                    | 419,879 |                                 
|$6.36 - $7.78            |  | 19,787             |  | 6.59                                                 |  |                                  | 7.49 |                    | 15,892  |                                 
|                         |  |                    |  |                                                      |  |                                  |      |                    |         |                                 
|                         |  | 3,503,164          |  | 8.84                                                 |  | $                                | 3.82 |                    | 997,271 |                                 
|                         |  |                    |  |                                                      |  |                                  |      |                    |         |                                 

NOTE 9. SHAREHOLDERS' EQUITY

Series A Preferred Stock

The Company's Series A Preferred Stock accrued a dividend of 7% per annum, compounded semi-annually and payable in shares of Series A
Preferred Stock. The Series A Preferred Stock was convertible at anytime between January 2002 and January 2006 into the Company's common stock. The original conversion price of the
Series A Preferred Stock was $12.00; however, as a result of the Company's March 2002 and October 2003 financings, the conversion price had been adjusted to $9.51 per share. In December 2004,
the Company entered into an agreement with the Series A Preferred shareholder to resolve a misunderstanding between the Company and the shareholder relating primarily to prior adjustments to
the conversion price of the Series A Preferred Stock. Pursuant to the agreement, among other matters, the Company agreed to adjust the conversion price to $7.50 per share. The Company and the
shareholder also agreed to binding interpretations of certain other terms related to the Series A Preferred Stock conversion price.

Prior
to December 2004, the amounts calculated as Series A Preferred stock dividends were accounted for as an adjustment to the conversion price following EITF Issue
No. 98-5,Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios(Issue No. 98-5). As a result of the modifications to the preferred stock agreement in December 2004, the Company determined that a "significant modification" of the agreement had
been made, and, therefore, a new "commitment date" for accounting purposes had been established on December 10, 2004. The Company measured the difference between the carrying value of the
preferred stock and the fair value of the modified preferred stock pursuant to EITF Topic No. D-42,The Effect on the Calculation of Earnings per Share for
the Redemption or Induced Conversion of Preferred Stockand determined that the fair value of the modified security was less than the carrying value of the security prior to
the modification. The Company also evaluated the effective conversion rate, after considering the reset rate of $7.50 per share in addition to the common stock issuable upon conversion of the unpaid,
accumulated dividends. The fair value of the underlying common stock on December 10, 2004 was $5.06 per share. The Company determined that the conversion rate, after including the effect of the
unpaid dividends, did not result in a beneficial conversion feature, which could have had the effect

97

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9. SHAREHOLDERS' EQUITY (Continued)

of
also providing a deemed dividend to the preferred shareholder. However, an anti-dilution provision of the Series A Preferred Stock was triggered by the Company's January 2005
financing, which adjusted the conversion price of the Series A Preferred Stock to $7.12. As a result of the adjusted conversion price and an increase in the amount of common stock issuable upon
conversion of the Series A Preferred Stock due to additional accumulated dividends, the Series A Preferred Stock now contains a "beneficial conversion feature" subject to recognition
pursuant to Issue No. 98-5.

In
conjunction with the modification of the agreement, the Company issued a warrant to the Series A Preferred shareholder. The value of the warrant was considered in determining
the value of the modified security. The warrant is convertible into shares of the Company's common stock during the period between January 2006 and January 2009. The conversion price of the warrant
initially was $7.12, which was equal to the Series A Preferred Stock conversion price in effect as of January 20, 2006. The conversion price of the warrant decreases by approximately
4.8% per year during the conversion period, such that the number of shares of the Company's common stock issuable upon conversion of the warrant will increase by approximately 5.1% per year. The
conversion of the warrant will be satisfied only by surrender of the outstanding shares of Series A Preferred Stock.

The
Series A Preferred Stock accrued dividends through January 20, 2006, which is the date the warrant initially became exercisable. As a result of the issuance of the
warrant, the preferred stock may be surrendered in exchange for common stock for an additional three years through January 20, 2009. As long as the Series A Preferred Stock remains
outstanding, the number of shares into which the warrant can be converted increases as the conversion price of the warrant decreases resulting in additional deemed dividends on the Series A
Preferred Stock. For the years ended December 31, 2007, 2006 and 2005, the Company recognized Series A Preferred Stock deemed dividends of approximately $0.7 million,
$0.7 million and $0.8 million, respectively, attributable to the beneficial conversion feature from the accrued dividends and decreasing warrant price. The Company will continue to
recognize Series A Preferred Stock deemed dividends until the earlier of, the time the Series A Preferred Stock is surrendered or until January 2009.

As
of December 31, 2007, there were 18,158 shares of Series A Preferred Stock outstanding with an aggregate liquidation preference of approximately $18.2 million.
The warrant was convertible into 2,807,707 shares of the Company's common stock at a conversion price of $6.47 as of December 31, 2007.

Employee Stock Purchase Plan

In May 2004, the ESPP was approved by the shareholders. The ESPP is qualified under Section 423 of the Internal Revenue Code. The ESPP is designed to allow
eligible employees to purchase shares of the Company's common stock through periodic payroll deductions. The price of the common stock purchased under the ESPP must be equal to at least 85% of the
lower of the fair market value of the common stock on the commencement date of each offering period or the specified purchase date. The number of shares authorized for issuance under the ESPP as of
December 31, 2007 was 1,000,000, of which 581,955 shares were available for future issuance.

In
2007, the Company sold 136,731 shares of its common stock under the ESPP. The shares were purchased at a weighted average purchase price of $2.79 with proceeds of approximately
$0.4 million. In 2006, the Company sold 131,223 shares of its common stock under the ESPP. The shares were purchased at a weighted average purchase price of $3.25 with proceeds of approximately
$0.4 million.

98

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9. SHAREHOLDERS' EQUITY (Continued)

Warrant and Option Exercises

During 2007, the Company issued 27,988 shares of common stock to warrant holders subject to a cashless exercise feature of the exercised warrants. As of
December 31, 2007, there were 419,154 shares of common stock reserved for issuance for all outstanding warrants with a weighted-average exercise price of $2.16. The outstanding warrants are
fully exercisable and expire in April 2008.

Employees
and consultants exercised options to purchase 268,554 shares of the Company's common stock with net proceeds to the Company of approximately $0.8 million during the year
ended December 31, 2007. Employees and consultants exercised options to purchase 228,006 shares of the Company's common stock with net proceeds to the Company of approximately
$0.5 million during the year ended December 31, 2006.

Shareholder Rights Plan

On April 21, 2005, the Company adopted a shareholder rights plan, (the Rights Plan). Under the Rights Plan, the Company distributed one preferred share
purchase right for each share of common stock outstanding at the close of business on May 5, 2005. If a person or group acquires 20% or more of the Company's common stock in a transaction not
pre-approved by the Company's Board of Directors, each right will entitle its holder, other than the acquirer, to buy additional shares of the Company's common stock at 50% of its market
value, as defined in the Rights Plan. In addition, if an unapproved party acquires more than 20% of the Company's common stock, and the Company is later acquired by the unapproved party or in a
transaction in which all shareholders are not treated alike, shareholders with unexercised rights, other than the unapproved party, will be entitled to receive upon exercise of the rights, common
stock of the merger party or asset buyer with a value of twice the exercise price of the rights. Each right also becomes exercisable for one one-thousandth of a share of the Company's
Series RP preferred stock at the right's then current exercise price ten days after an unapproved third party makes, or announces an intention to make, a tender offer or exchange offer that, if
completed, would result in the unapproved party acquiring 20% or more of the Company's common stock. The Board of Directors may redeem the rights for a nominal amount before an event that causes the
rights to become exercisable. The rights will expire on April 21, 2015.

Equity Line of Credit

In December 2006, the Company entered into a common stock purchase agreement with Azimuth Opportunity, Ltd., which provides that, upon the terms and
conditions set forth in the purchase agreement, Azimuth is committed to purchase up to the lesser of (a) $30,000,000 of the Company's common stock, or (b) 8,399,654 shares of common
stock, which was equal to the number of shares that is one less than 20% of the issued and outstanding shares of the Company's common stock as of December 11, 2006, over the 24 month
term of the purchase agreement. From time to time over the term of the Purchase Agreement, and at the Company's discretion, the Company may present Azimuth with draw down notices requiring Azimuth to
purchase a specified dollar amount of shares of its common stock, subject to certain limits and so long as specified conditions are met. The shares of common stock will be sold at a discount ranging
from 3.775% to 6.375%, which varies based on a threshold price set by the Company. Upon each sale of the Company's common stock to Azimuth under the agreement, the Company has also agreed to pay
Reedland Capital Partners a placement fee equal to 1.125% of the aggregate dollar amount of common stock purchased by Azimuth. Azimuth is

99

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9. SHAREHOLDERS' EQUITY (Continued)

not
required to purchase the Company's common stock when the price of the Company's common stock is below $2 per share. As of December 31, 2007, the Company has not sold any shares under this
common stock purchase agreement.

NOTE 10. RELATED PARTY TRANSACTIONS

Retirement of John W. Fara, Ph.D.

In August 2007, John W. Fara, Ph.D. retired from his positions as President, Chief Executive Officer and Chairman of the Company. Dr. Fara will continue to
serve as a member of the Company's Board of Directors. The Company entered into a consulting agreement with Dr. Fara, pursuant to which Dr. Fara will provide consulting services to the
Company through December 31, 2009. From August 2007 through December 31, 2008, the Company will pay Dr. Fara $20,833 per month for his consulting services, and will reimburse
Dr. Fara for COBRA and life insurance premiums. Dr. Fara will be paid on an hourly basis for consulting services provided in 2009. For the year ended December 31, 2007, the
Company incurred expense of approximately $90,000 associated with this consulting agreement.

During
the period of his consultancy, Dr. Fara will continue to vest in all of his currently unvested stock options, and his vested stock options will remain exercisable. For the
year ended December 31, 2007, the Company recognized approximately $67,000 in stock compensation expense associated with these awards.

In
the event of a change in control of the Company, as defined by the Company's 2004 Equity Incentive Plan, all of Dr. Fara's unvested options will fully vest, and any remaining
monthly payments for consulting under the agreement will be accelerated.

Retirement of John F. Hamilton

In October 2007, John F. Hamilton retired from his position as Vice President, Finance and Chief Financial Officer of the Company. The Company entered into a
letter agreement with the Mr. Hamilton, pursuant to which the Company made a $190,000 lump sum payment to Mr. Hamilton. Options to purchase the Company's common stock held by
Mr. Hamilton on retirement were cancelled
in October 2007 and were exchanged for 100,000 fully vested shares of common stock pursuant to the Company's 2004 Equity Incentive Plan. The Company will also reimburse Mr. Hamilton for COBRA
premiums.

The
Company treated the issuance of fully vested shares of common stock in exchange for the cancellation of Mr. Hamilton's options as a modification of the terms of the cancelled
options for accounting purposes. The Company recognized approximately $364,000 of stock-based compensation expense related to this transaction, which represented the remaining unrecognized
compensation costs associated with Mr. Hamilton's cancelled options on the date of settlement.

The
Company also entered into a consulting agreement with Mr. Hamilton, pursuant to which Mr. Hamilton will provide consulting services to the Company through
October 10, 2008. From October 10, 2007 through October 10, 2008, the Company will pay Mr. Hamilton $25,667 per month for his consulting services. For the year ended
December 31, 2007, the Company incurred expense of approximately $64,000 associated with this consulting agreement. At December 31, 2007, the Company had approximately $51,000 included
in accounts payable related to this consulting arrangement, which

100

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 10. RELATED PARTY TRANSACTIONS (Continued)

was
paid in full in January 2008. In the event of a change in control of the Company, as defined by the Company's 2004 Equity Incentive Plan, any remaining monthly payments for consulting under the
agreement will be accelerated.

NOTE 11. REDUCTION IN FORCE

In September 2007, the Company reduced its workforce by 25 employees, or approximately 25% of its full-time staff, to conserve cash and align its
workforce with its anticipated staffing needs. The total cost of the workforce reduction was approximately $0.7 million, which consisted of cash payments for severance, medical insurance and
outplacement services and was recognized as expense during the year ended December 31, 2007. Severance expense of approximately $0.4 million and $0.3 million was recognized in
research and development expense and selling, general and administrative expense, respectively, for the year ended December 31, 2007.

NOTE 12. INCOME TAXES

The provision for income taxes consists of the following (in thousands):

Year Ended December 31,Current:2007

2006

2005Federal

$
470

$


$
State


118





Foreign


4


83


592


83


Deferred:Federal








State








Foreign














Total provision for income taxes

$
592

$
83

$



A
reconciliation of income taxes at the statutory federal income tax rate to the actual tax rate included in the statements of operations is as follows (in thousands):

Year Ended December 31,2007

2006

2005Tax at federal statutory rate

$
16,936

$
(13,457
)
$
(8,319
)State tax, net of federal benefit


118





Foreign tax


4


83


Net operating losses


(17,364
)

12,674


8,250FederalAMT


470





Other


428


783


69$
592

$
83

$



101

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 12. INCOME TAXES (Continued)

For
the year ended December 31, 2007, federal and state income tax provisions were based on the Company's alternative minimum tax, as the Company utilized net operating loss
carryforwards. No provision for federal or state income taxes has been recorded for the years ended December 31, 2006 and 2005 due to operating losses. The Company's tax provision for the year
ended December 31, 2006 is solely due to foreign taxes withheld on license revenue related to the Company's agreement with LG by
the Republic of Korea. As of December 31, 2007, the Company had net operating loss carryforwards for federal income tax purposes of approximately $88.6 million, which expire in the years
2021 through 2026 and federal research and development tax credits of approximately $3.3 million which expire in the years 2011 through 2026. Net operating loss carryforwards for state income
tax purposes were approximately $59.0 million, which expire in the years 2013 through 2016 and state research and development tax credits were approximately $3.4 million which have no
expiration date. The Company has federal and state alternative minimum tax credit carryforwards of $0.5 million and $0.1 million, respectively, which have no expiration date. Additionally, the Company
has foreign tax credit carryforwards of $0.2 million, which begin to expire in 2014.

Utilization
of the Company's net operating loss and credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations provided by the Internal
Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization.

Deferred
income taxes reflect the net tax effects of net operating loss and tax credit carryovers and temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets are as follows (in thousands):

Year Ended December 31,Deferred Tax Assets:2007

2006

2005Net operating loss carryforwards

$
33,100

$
41,900

$
40,400Tax carryforwards


6,300


4,500


3,000In-process research and development


3,100


3,500


3,900Capitalized research expenses


1,500


1,800


2,200Deferred revenue


11,500


22,700


10,000Other, net


1,200


1,600


400Total deferred tax assets


56,700


76,000


59,900Valuation allowance for deferred tax assets


(56,700
)

(76,000
)

(59,900
)Deferred tax assets, net

$


$


$



Realization
of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully
offset by a valuation allowance. The valuation allowance decreased by $19.3 million during the years ended December 31, 2007, and increased by $16.1 million and
$13.7 million 2006 and 2005, respectively.

On
January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxesan
interpretation of FASB Statement No. 109(FIN 48), which clarifies the accounting for uncertainty in tax positions. The Company did not recognize any

102

---



DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 12. INCOME TAXES (Continued)

adjustment
to the liability for uncertain tax positions and therefore did not record any adjustment to the beginning balance of retained earnings on the balance sheet.

The
Company files income tax returns in the United States federal jurisdiction and in various states, and the tax returns filed for the years 1995 through 2006 have not been examined and
the applicable statutes of limitation have not expire with respect to those returns. Because of net operating loss and research credit carryovers, substantially all of the Company's tax years remain
open to examination.

Interest
and penalties, if any, related to unrecognized tax benefits, would be recognized as income tax expense by the Company. As of the date of adoption of FIN 48, the Company
did not have any accrued interest or penalties associated with any unrecognized tax benefits.

The
following table summarizes the activity related to our unrecognized tax benefits for the year ended December 31, 2007 (in thousands):

Unrecognized tax benefitsJanuary 1, 2007

$
2,306Gross increasesprior year tax positions


Gross increasescurrent year tax positions


586Settlements with taxing authorities


Expiration of statute of limitations


Unrecognized tax benefitsDecember 31, 2007

$
2,892


Though
our unrecognized tax benefits may change during the next year for items that arise in the ordinary course of business, we do not expect any such change to be significant.

NOTE 13. SUMMARIZED QUARTERLY DATA (UNAUDITED)

The following tables set forth certain consolidated statements of operations data for each of the eight quarters beginning with the quarter ended March 31,
2006 through the quarter ended December 31, 2007 (in thousands). This quarterly information is unaudited, but has been prepared on the same basis as the annual consolidated financial statements
and, in the opinion of management, reflects all adjustments, consisting only of normal recurring adjustments necessary for a fair

103

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DEPOMED, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 13. SUMMARIZED QUARTERLY DATA (UNAUDITED) (Continued)

representation
of the information for the periods presented. Operating results for any quarter are not necessarily indicative of results for any future period.

|                                                          |  | 2007 Quarter Ended |        
|--------------------------------------------------------- |  | ------------------ | -------
|
|Product sales                                             |  | $                  | 1,332  
|Total revenues                                            |  |                    | 3,829  
|Gross margin on product sales                             |  |                    | 1,026  
|Gain on termination of King agreement                     |  |                    |       
|Gain on termination of Esprit agreements                  |  |                    |       
|Income (loss) from operations                             |  |                    | (11,276
|Net income (loss)                                         |  |                    | (10,866
|Net income (loss) applicable to common stock shareholders |  |                    | (11,033
|Basic net income (loss) per share                         |  | $                  | (0.26  
|Diluted net income (loss) per share                       |  | $                  | (0.26  

|
|

|                                                 |  | 2006 Quarter Ended |       
|------------------------------------------------ |  | ------------------ | ------
|
|Product sales                                    |  | $                  | 100   
|Total revenues                                   |  |                    | 1,342 
|Gross margin on product sales                    |  |                    | 25    
|Loss from operations                             |  |                    | (8,348
|Net loss                                         |  |                    | (7,753
|Net loss applicable to common stock shareholders |  |                    | (7,925
|Basic and diluted net loss per share             |  | $                  | (0.19 

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SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS

|                                                      |                              |  |   | Additions |  |   |       | 
|----------------------------------------------------- | ---------------------------- |  | - | --------- |  | - | ----- | 
|
|
|Sales allowances, discounts, chargebacks and rebates: |                              |  |   |           |  |   |       | 
|                                                      | Year ended December 31, 2007 |  | $ | 371       |  | $ | 1,726 | 
|                                                      | Year ended December 31, 2006 |  |   |          |  |   | 131   | 
|                                                      | Year ended December 31, 2005 |  |   |          |  |   |      | 

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