Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

#### **FORM 10-Q**

#### ** **

| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**FOR THE QUARTERLY PERIOD ENDED March 31, 2010**

 

**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 001-13111**

 

**DEPOMED, INC.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

| **CALIFORNIA**                  | ** ** | **94-3229046**         |
|---------------------------------|------------|------------------------|
| (STATE OR OTHER JURISDICTION OF |       | (I.R.S. EMPLOYER       |
| INCORPORATION OR ORGANIZATION)  |       | IDENTIFICATION NUMBER) |

 

**1360 O’BRIEN DRIVE**

**MENLO PARK, CALIFORNIA 94025**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

 

**(650) 462-5900**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

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

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes  o   No  o

 

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

 

| Large accelerated filer o |   | Accelerated filer x         |
|---------------------------|--------|-----------------------------|
|                      |   |                        |
| Non-accelerated filer o   |   | Smaller reporting company o |

 

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

 

Thenumber of issued and outstanding shares of the Registrant’s Common Stock, nopar value, as of April 30, 2010 was 52,370,998.

 

 

 

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Table ofContents

 

**DEPOMED, INC.**

 
| ** **                                                                                               | ** ** | **PAGE** |
|----------------------------------------------------------------------------------------------------------|------------|----------|
| ** **                                                                                               |       |     |
| **PART I  — FINANCIAL INFORMATION**                                                            |       |     |
|                                                                                                     |       |     |
| Item 1. Condensed Financial  Statements:                                                                 |       |     |
|                                                                                                     |       |     |
| Condensed  Balance Sheets at March 31, 2010 (unaudited) and December 31, 2009                  |       | 3        |
|                                                                                                     |       |     |
| Condensed  Statements of Operations for the three months ended March 31, 2010 and  2009 (unaudited) |       | 4        |
|                                                                                                     |       |     |
| Condensed  Statements of Cash Flows for the three months ended March 31, 2010 and  2009 (unaudited) |       | 5        |
|                                                                                                     |       |     |
| Notes to  Condensed Financial Statements (unaudited)                                                     |       | 6        |
|                                                                                                     |       |     |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations     |       | 16       |
|                                                                                                     |       |     |
| Item 3.  Quantitative and Qualitative Disclosure About Market Risk                                       |       | 24       |
|                                                                                                     |       |     |
| Item 4. Controls  and Procedures                                                                         |       | 25       |
|                                                                                                     |       |     |
| **PART II — OTHER  INFORMATION**                                                               |       |     |
|                                                                                                     |       |     |
| Item 1. Legal  Proceedings                                                                               |       | 26       |
|                                                                                                     |       |     |
| Item 1A. Risk Factors                                                                                    |       | 26       |
|                                                                                                     |       |     |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                     |       | 38       |
|                                                                                                     |       |     |
| Item 3.  Defaults upon Senior Securities                                                                 |       | 38       |
|                                                                                                     |       |     |
| Item 4. Reserved                                                                                         |       | 38       |
|                                                                                                     |       |     |
| Item 5. Other  Information                                                                               |       | 38       |
|                                                                                                     |       |     |
| Item 6. Exhibits                                                                                         |       | 39       |
|                                                                                                     |       |     |
| Signatures                                                                                               |       | 40       |

 

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**PART I— FINANCIAL INFORMATION**

###### **ITEM 1. CONDENSED FINANCIAL STATEMENTS**

 

**DEPOMED, INC.**

**CONDENSEDBALANCE SHEETS**

**(in thousands, except share amounts)**

 
| ** **                                                                                                                                                                                                                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                              | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                                                                                              | ** ** | **(Unaudited)**    | ** ** | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                                                                              | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                                                                         |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                               |       | $                  | 7,424      |                  | $          | 26,821 |   |
| Marketable securities                                                                                                                                                                                                                                   |       | 51,527             |       | 42,922                |       |
| Accounts receivable                                                                                                                                                                                                                                     |       | 6,276              |       | 4,933                 |       |
| Inventories                                                                                                                                                                                                                                             |       | 2,760              |       | 2,565                 |       |
| Prepaid and other current assets                                                                                                                                                                                                                        |       | 2,634              |       | 1,185                 |       |
| Total current assets                                                                                                                                                                                                                                    |       | 70,621             |       | 78,426                |       |
| Marketable securities, long-term                                                                                                                                                                                                                        |       | 12,524             |       | 12,016                |       |
| Property and equipment, net                                                                                                                                                                                                                             |       | 871                |       | 942                   |       |
| Other assets                                                                                                                                                                                                                                            |       | 197                |       | 197                   |       |
|                                                                                                                                                                                                                                                    |       | $                  | 84,213     |                  | $          | 91,581 |   |
| **LIABILITIES AND  SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                          |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                    |       |               |       |                  |       |
| Accounts payable and accrued liabilities                                                                                                                                                                                                                |       | 14,452             |       | 15,222                |       |
| Deferred product sales                                                                                                                                                                                                                                  |       | 1,594              |       | 1,635                 |       |
| Deferred license revenue                                                                                                                                                                                                                                |       | 11,159             |       | 11,184                |       |
| Other current liabilities                                                                                                                                                                                                                               |       | 425                |       | 414                   |       |
| Current portion of long-term debt                                                                                                                                                                                                                       |       | 3,859              |       | 3,747                 |       |
| Total current liabilities                                                                                                                                                                                                                               |       | 31,489             |       | 32,202                |       |
| Deferred license revenue, non-current portion                                                                                                                                                                                                           |       | 38,660             |       | 41,306                |       |
| Long-term debt, net of current portion                                                                                                                                                                                                                  |       | 1,160              |       | 2,170                 |       |
| Other long-term liabilities                                                                                                                                                                                                                             |       | 143                |       | 177                   |       |
| Commitments                                                                                                                                                                                                                                             |       |               |       |                  |       |
| Shareholders’ equity:                                                                                                                                                                                                                              |       |               |       |                  |       |
| Preferred stock, no par value, 5,000,000 shares  authorized; Series A convertible preferred stock, 25,000 shares  designated, 18,158 shares issued and surrendered, and zero shares outstanding  at March 31, 2010 and December 31, 2009 |       | —             |       | —                |       |
| Common stock, no par value, 100,000,000 shares  authorized; 52,354,402 and 52,200,358 shares issued and outstanding at  March 31, 2010 and December 31, 2009, respectively                                                                    |       | 188,756            |       | 187,895               |       |
| Accumulated deficit                                                                                                                                                                                                                                     |       | (176,029           | )          | (172,202              | )          |
| Accumulated other comprehensive gain                                                                                                                                                                                                                    |       | 34                 |       | 33                    |       |
| Total shareholders’ equity                                                                                                                                                                                                                         |       | 12,761             |       | 15,726                |       |
|                                                                                                                                                                                                                                                    |       | $                  | 84,213     |                  | $          | 91,581 |   |

 

----

(1) Derived from the audited financial statements included in theCompany’s Annual Report on Form 10-K for the year ended December 31,2009.

 

See accompanying notes to CondensedFinancial Statements.

 

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**DEPOMED, INC.**

**CONDENSED STATEMENTS OF OPERATIONS**

**(in thousands, except share and per share amounts)**

**(Unaudited)**

 
| ** **                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                     | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Revenues:                                                      |       |                                  |       |   |   |
| Product sales                                                  |       | $                                     | 12,601     |   | $ | 6,840 |   |
| Royalties                                                      |       | 88                                    |       | 464 |   |
| License and milestone  revenue                                 |       | 2,671                                 |       | 2,568 |   |
| Total revenues                                                 |       | 15,360                                |       | 9,872 |   |
| Costs and expenses:                                            |       |                                  |       |   |   |
| Cost of sales                                                  |       | 1,481                                 |       | 1,032 |   |
| Research and development  expense                              |       | 5,187                                 |       | 10,021 |   |
| Selling, general and  administrative expense:                  |       |                                  |       |   |   |
| Promotion fee expense                                          |       | 8,879                                 |       | 4,544 |   |
| Other selling, general and  administrative expense             |       | 3,550                                 |       | 4,458 |   |
| Total selling, general and  administrative expense             |       | 12,429                                |       | 9,002 |   |
| Total costs and expenses                                       |       | 19,097                                |       | 20,055 |   |
| Loss from operations                                           |       | (3,737                                | )          | (10,183 | ) |
| Other income (expense):                                        |       |                                  |       |   |   |
| Interest and other income                                      |       | 94                                    |       | 314 |   |
| Interest expense                                               |       | (183                                  | )          | (285 | ) |
| Total other income  (expense)                                  |       | (89                                   | )          | 29 |   |
| Net loss before income  taxes                                  |       | (3,826                                | )          | (10,154 | ) |
| Provision for income taxes                                     |       | (1                                    | )          | (1 | ) |
| Net loss                                                       |       | $                                     | (3,827     | ) | $ | (10,155 | ) |
| Basic and diluted net loss  per share                          |       | $                                     | (0.07      | ) | $ | (0.20 | ) |
| Shares used in computing basic and diluted net  loss per share |       | 52,298,726                            |       | 51,207,540 |   |

 

See accompanying notes to Condensed Financial Statements.

 

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**DEPOMED, INC.**

**CONDENSED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| **Operating Activities**                                                                   | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                                      | (3,827     | ) | $ | (10,155 | ) |
| Adjustments to reconcile net loss to net cash (used  in) provided by operating activities: |       |                                   |       |   |   |
| Depreciation and amortization                                                              |       | 153                                    |       | 214 |   |
| Stock-based compensation                                                                   |       | 545                                    |       | 694 |   |
| Changes in assets and liabilities:                                                         |       |                                   |       |   |   |
| Accounts receivable                                                                        |       | (1,343                                 | )          | (323 | ) |
| Inventories                                                                                |       | (195                                   | )          | (53 | ) |
| Other current assets                                                                       |       | (1,449                                 | )          | 1,933 |   |
| Accounts payable and other accrued liabilities                                             |       | 539                                    |       | (309 | ) |
| Accrued compensation                                                                       |       | (1,331                                 | )          | (1,478 | ) |
| Deferred revenue                                                                           |       | (2,712                                 | )          | 22,376 |   |
| Net cash (used in) provided by operating activities                                        |       | (9,620                                 | )          | 12,899 |   |
|                                                                                       |       |                                   |       |   |   |
| **Investing Activities**                                                                   | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                        |       | (49                                    | )          | (84 | ) |
| Purchases of marketable securities                                                         |       | (32,546                                | )          | (63,523 | ) |
| Maturities of marketable securities                                                        |       | 20,932                                 |       | 32,847 |   |
| Sales of marketable securities                                                             |       | 2,490                                  |       | 6,010 |   |
| Net cash used in investing activities                                                      |       | (9,173                                 | )          | (24,750 | ) |
|                                                                                       |       |                                   |       |   |   |
| **Financing Activities**                                                                   | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Principal payments on long-term debt                                                       |       | (921                                   | )          | (714 | ) |
| Proceeds from issuance of common stock                                                     |       | 317                                    |       | 26 |   |
| Net cash used in financing activities                                                      |       | (604                                   | )          | (688 | ) |
|                                                                                       |       |                                   |       |   |   |
| Net decrease in cash and cash equivalents                                                  |       | (19,397                                | )          | (12,539 | ) |
| Cash and cash equivalents at beginning of period                                           |       | 26,821                                 |       | 22,127 |   |
| Cash and cash equivalents at end of period                                                 |       | $                                      | 7,424      |   | $ | 9,588 |   |

 

See accompanying notes to Condensed Financial Statements.

 

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** **

**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

## ***Basis of Presentation***

## * *

These unaudited Condensed Financial Statements and therelated footnote information of Depomed, Inc. (the Company or Depomed)have been prepared pursuant to the requirements of the Securities and ExchangeCommission (SEC) for interim reporting. As permitted under those rules andregulations, certain footnotes or other financial information that are normallyrequired by U.S. generally accepted accounting principles have been condensedor omitted pursuant to such rules and regulations. In the opinion of theCompany’s management, the accompanying interim unaudited condensed financialstatements include all adjustments (consisting only of normal recurringadjustments) necessary for a fair presentation of the information for theperiods presented. The results for the interim period ended March 31, 2010are not necessarily indicative of results to be expected for the entire yearending December 31, 2010 or future operating periods.

 

The accompanying Condensed Financial Statements andrelated financial information should be read in conjunction with the audited financialstatements and the related notes thereto for the year ended December 31,2009, included in our Annual Report on Form 10-K filed with the SEC. Thecondensed balance sheet at December 31, 2009 has been derived from auditedfinancial statements at that date.

 

***Use of Estimates***

 

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

 

***Revenue Recognition***

 

The Company recognizes revenue from the sale of itsproducts, royalties earned, and on payments received and services performedunder contractual arrangements. Revenue arrangements with multiple elements aredivided into separate units of accounting if applicable criteria are met,including whether the delivered element has stand-alone value to the customerand whether there is objective and reliable evidence of the fair value of theundelivered items. The consideration received is allocated among the separateunits based on their respective fair values, and the applicable revenuerecognition criteria are applied to each of the separate units.

 

Revenue is recognized when there is persuasiveevidence that an arrangement exists, delivery has occurred and title haspassed, the price is fixed or determinable and the Company is reasonablyassured of collecting the resulting receivable.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

·                  Product Sales:

 

·                  *GLUMETZA**®*: The Company sells GLUMETZA*®* (metforminhydrochloride extended release tablets) to wholesalers and retail pharmaciessubject to rights of return six months before expiration and up to twelvemonths after product expiration. The Company recognizes revenue for GLUMETZAsales at the time title transfers to its customers, which occurs at the timeproduct is delivered to its customers.

 

·                  *Proquin**®XR*: The Company sells Proquin® XR (ciprofloxacinhydrochloride) to wholesalers and retail pharmacies subject to rights of returnsix months before expiration and up to twelve months after product expiration. Giventhe Company’s limited history of selling Proquin XR and decreasing prescriptiondemand for Proquin XR, the Company currently cannot reliably estimate expectedreturns of the product at the time of shipment. Accordingly, the Company defersrecognition of revenue on product shipments of Proquin XR until the right ofreturn no longer exists, which occurs at the earlier of the time Proquin XRunits are dispensed through patient prescriptions or expiration of the right ofreturn. The Company estimates patient prescriptions dispensed using an analysisof third-party information, including third-party market research data andinformation obtained from wholesalers with respect to inventory levels andinventory movement. As a result of this policy, the Company has a deferredrevenue balance of $1.6 million at March 31, 2010 related to Proquin XRproduct shipments that have not been recognized as revenue, which is net ofwholesaler fees, retail pharmacy discounts and prompt payment discounts. TheCompany will recognize revenue upon the earlier to occur of prescription unitsdispensed or the expiration of the right of return until it can reliablyestimate product returns, at which time the Company will record a one-timeincrease in net revenue related to the recognition of revenue previouslydeferred. In addition, the costs of manufacturing Proquin XR associated withthe deferred revenue are recorded as deferred costs, which are included ininventory, until such time the related deferred revenue is recognized.

 

·                  ProductSales Allowances — The Company recognizes product sales allowances as areduction of product sales in the same period the related revenue isrecognized. Product sales allowances are based on amounts owed or to be claimedon the related sales. These estimates take into consideration the terms of theCompany’s agreements with customers, historical product returns, rebates ordiscounts taken, estimated levels of inventory in the distribution channel, theshelf life of the product, and specific known market events, such ascompetitive pricing and new product introductions. If actual future resultsvary from the Company’s estimates, the Company may need to adjust theseestimates, which could have an effect on product sales and earnings in theperiod of adjustment. The Company’s product sales allowances include:

 

·                  ProductReturns — The Company estimates product returns on sales of GLUMETZA. TheCompany allows customers to return product that is within six months before andup to twelve months after its product expiration date. The shelf life of the500mg GLUMETZA is currently 48 months from the date of tablet manufacture. Onproduct launch in August 2006 and through the second quarter of 2008, theshelf life of 500mg GLUMETZA product shipped was 36 months from the date oftablet manufacture. During March 2010, the Company began shipping 1000mgGLUMETZA with a shelf life of 36 months from the date of tablet manufacture. Priorto March 2010, the 1000mg GLUMETZA shelf life on product shipped tocustomers was 24 months from the date of tablet manufacture. The Companymonitors actual return history on individual product lot basis since productlaunch, which provides it with a basis to reasonably estimate future productreturns, taking into consideration the shelf life of product, shipment andprescription trends, estimated distribution channel inventory levels, thereturn rates of companies with products that have similar characteristics andsimilar return policies within the metformin prescription market, as well asconsideration of the introduction of competitive products.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

·                  Managed CareRebates — The Company offers rebates under contracts with certain managed carecustomers. The Company establishes an accrual equal to its estimates of futuremanaged care rebates attributable to sales and recognizes the estimated rebatesas a reduction of revenue in the same period the related revenue is recognized.The Company estimates its managed care rebates based on the terms of eachagreement, estimated levels of inventory in the distribution channel, andhistorical and expected future utilization of product by the managed careorganization.

 

·                  Wholesalerand Retail Pharmacy Discounts — The Company offers discounts to certainwholesale distributors and retail pharmacies based on contractually determinedrates. The Company accrues the discount on shipment to the respective wholesaledistributors and retail pharmacies and recognizes the discount as a reductionof revenue in the same period the related revenue is recognized.

 

·                  Prompt PayDiscounts - The Company offers cash discounts to its customers, generally 2% ofthe sales price, as an incentive for prompt payment. Based on the Company’sexperience, the Company expects its customers to comply with the payment termsto earn the cash discount. The Company accounts for cash discounts by reducingaccounts receivable by the full amount and recognizes the discount as areduction of revenue in the same period the related revenue is recognized.

 

·                  MedicaidRebates — The Company participates in Medicaid rebate programs, which provideassistance to certain eligible low-income patients based on each individualstate’s guidelines regarding eligibility and services. Under the Medicaidrebate programs, the Company pays a rebate to each participating state,generally two to three months after the quarter in which the prescription isfilled. The Company estimates and accrues Medicaid rebates based on productpricing, current rebates and changes in the level of discounts the Companyoffers that may affect the level of Medicaid discount, historical and estimatedfuture percentages of product sold to Medicaid recipients and estimated levelsof inventory in the distribution channel.

 

·                  Chargebacks —The Company provides discounts to authorized users of the Federal SupplySchedule (FSS) of the General Services Administration under an FSS contractwith the Department of Veterans Affairs. These federal entities purchaseproducts from the wholesale distributors at a discounted price, and thewholesale distributors then charge back to the Company the difference betweenthe current retail price and the price the federal entity paid for the product.The Company estimates and accrues chargebacks based on estimated wholesalerinventory levels, current contract prices and historical chargeback activity.

 

·                  PatientDiscount Programs — The Company offers loyalty card programs to patients forGLUMETZA in which patients receive certain discounts at participating retailpharmacies that are reimbursed by the Company. The Company estimates andaccrues future redemptions based on historical redemption activity.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

·                  Royalties —Royalties are recognized as earned in accordance with the contract terms whenroyalties from licensees can be reliably measured and collectibility isreasonably assured.

 

In April 2008, theCompany entered into a settlement and license agreement with TevaPharmaceuticals USA, Inc. (Teva) in which the Company was entitled toreceive royalties from Teva on sales by Teva or its affiliates of genericGlucophage®XR in the United States, subject to a $2.5 million aggregate royaltycap that was met during 2009. The royalties were calculated as a percentage ofsales by Teva of generic Glucophage XR in the United States, as reported by athird-party market research company. The Company accrued royalties from Tevaeach quarter based on Teva’s sales of generic Glucophage XR reported by thethird-party market research company for that quarter. As the $2.5 millionroyalty cap was met in 2009, there were no royalties under this agreement in2010.

 

Royalties received underthe Company’s agreements with Biovail Laboratories s.r.l. (Biovail) and LG LifeSciences (LG) are recognized when the royalty payments are received as theycannot reliably be estimated.

 

·                  License andCollaborative Arrangements - Revenue from license and collaborativearrangements is recognized when the Company has substantially completed itsobligations under the terms of the arrangement and the Company’s remaininginvolvement is inconsequential and perfunctory. If the Company has significantcontinuing involvement under such an arrangement, license and collaborativefees are recognized over the estimated performance period. The Companyrecognizes milestone payments upon the achievement of specified milestones if (1) themilestone is substantive in nature, and the achievement of the milestone wasnot reasonably assured at the inception of the agreement and (2) the feesare nonrefundable. License, milestones and collaborative fee payments receivedin excess of amounts earned are classified as deferred revenue until earned.

 

***Recently Issued AccountingStandards***

* *

*In January 2010, theFinancial Accounting Standards Board (FASB) issued Accounting Standards Update(ASU) 2010-06,*Fair Value Measurements and Disclosures(Topic 820): Improving Disclosures about Fair Value Measurements (ASU 2010-06), which amends the existing fair value measurement anddisclosure guidance currently included in Accounting Standards CodificationTopic 820, Fair Value Measurements and Disclosures, to require additional disclosures regarding fair value measurements.Specifically, ASU 2010-06 requires entities to disclose the amounts ofsignificant transfers between Level 1 and Level 2 of the fair value hierarchyand the reasons for these transfers, the reasons for any transfer in or out ofLevel 3 and information in the reconciliation of recurring Level 3 measurementsabout purchases, sales, issuances and settlements on a gross basis. Inaddition, ASU 2010-06 also clarifies the requirement for entities to discloseinformation about both the valuation techniques and inputs used in estimatingLevel 2 and Level 3 fair value measurements. ASU 2010-06 is effective forinterim and annual reporting periods beginning after December 15, 2009,except for additional disclosures related to Level 3 fair value measurements,which are effective for fiscal years beginning after December 15, 2010.The Company expects to adopt ASU 2010-06 on January 1, 2011 and does notexpect to the adoption of ASU 2010-06 to have a material effect on itsfinancial statements.

* *

In September 2009,the FASB issued Accounting Standards Update 2009-13 (Topic 605), *Multiple-Deliverable Revenue Arrangements*(ASU2009-13)*.* ASU 2009-13 applies tomultiple-deliverable revenue arrangements that are currently within the scopeof the *Revenue Recognition —Multiple-Element Arrangements* topic of the Codification. ASU 2009-13provides principles and application guidance on whether multiple deliverablesexist, how the arrangement should be separated and the consideration allocated.ASU 2009-13 requires an entity to allocate revenue in an arrangement usingestimated selling prices of deliverables if a vendor does not havevendor-specific objective evidence or third-party evidence of selling price.ASU 2009-13 eliminates the use of the residual method and requires an entity toallocate revenue using the relative selling price method and also significantlyexpands the disclosure requirements for multiple-deliverable revenue arrangements.ASU 2009-13 should be applied on a prospective basis for revenue arrangementsentered into or materially modified in fiscal years beginning on or after June 15,2010, with earlier application permitted. The Company expects to adopt ASU2009-13 on January 1, 2011 and does not expect the adoption of ASU 2009-13to have a material impact on its financial statements.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS(Continued)**

***(Unaudited)***

* *

**NOTE 2. CASH, CASH EQUIVALENTS AND MARKETABLESECURITIES**

 

Securities classified asavailable-for-sale as of March 31, 2010 and December 31, 2009 aresummarized below (in thousands). Estimated fair value is based on quoted marketprices for these investments.

 
| **March 31, 2010**                                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
| U.S. debt securities:                                                        |       |                |       |                         |       |                          |       |           |       |
| Total included in cash and  cash equivalents                                 |       | $                   | 4,136      |                         | $          | —                        |       | $              | —     |   | $ | 4,136 |   |
| Total maturing within 1  year and included in marketable securities:         |       |                |       |                         |       |                          |       |           |       |
| U.S. corporate debt  securities                                              |       | 3,000               |       | 1                            |       |                          |       | 3,001          |       |
| U.S. government agency  debt securities                                      |       | 22,025              |       | 31                           |       | (7                            | )          | 22,049         |       |
| U.S. Treasury securities                                                     |       | 26,468              |       | 9                            |       | —                        |       | 26,477         |       |
| Total maturing between 1  and 2 years and included in marketable securities: |       |                |       |                         |       |                          |       |           |       |
| U.S. government agency  debt securities                                      |       | 6,029               |       | —                       |       | (4                            | )          | 6,025          |       |
| U.S. Treasury securities                                                     |       | 6,495               |       | 5                            |       | (1                            | )          | 6,499          |       |
| Total available-for-sale                                                     |       | $                   | 68,153     |                         | $          | 46                            |       | $              | (12        | ) | $ | 68,187 |   |

 
| **December 31, 2009**                                                   | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
| U.S. debt securities:                                                        |       |                |       |                         |       |                          |       | ** **     |       |
| Total included in cash and  cash equivalents                                 |       | $                   | 21,186     |                         | $          | —                        |       | $              | —     |   | $ | 21,186 |   |
| Total maturing within 1 year  and included in marketable securities:         |       |                |       |                         |       |                          |       |           |       |
| U.S. corporate debt  securities                                              |       | 7,900               |       | 1                            |       | —                        |       | 7,901          |       |
| U.S. government agency  debt securities                                      |       | 12,989              |       | 40                           |       | —                        |       | 13,029         |       |
| U.S. Treasury securities                                                     |       | 21,988              |       | 9                            |       | (5                            | )          | 21,992         |       |
| Total maturing between 1  and 2 years and included in marketable securities: |       |                |       |                         |       |                          |       |           |       |
| U.S. government agency  debt securities                                      |       | 12,028              |       | —                       |       | (12                           | )          | 12,016         |       |
| U.S. Treasury securities                                                     |       | —              |       | —                       |       | —                        |       | —         |       |
| Total available-for-sale                                                     |       | $                   | 79,091     |                         | $          | 50                            |       | $              | (17        | ) | $ | 76,124 |   |

 

TheCompany considers all highly liquid investments with a maturity at date ofpurchase of three months or less to be cash equivalents. Cash and cashequivalents consist of cash on deposit with banks, money market instruments andcommercial paper. The Company places its cash, cash equivalents and marketablesecurities with high quality, U.S. financial institutions and, to date, has notexperienced material losses on any of its balances. All marketable securitiesare classified as available-for-sale since these instruments are readilymarketable. These securities are carried at fair value, which is based onreadily available market information, with unrealized gains and losses includedin accumulated other comprehensive gain or loss within shareholders’ equity.The Company uses the specific identification method to determine the amount ofrealized gains or losses on sales of marketable securities. Realized gains orlosses have been insignificant and are included in “interest and other income”in the condensed statement of operations. As of March 31, 2010, theindividual contractual period for all available-for-sale debt securities isless than two years.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS(Continued)**

***(Unaudited)***

* *

At March 31, 2010,the Company had thirteen securities in an unrealized loss position. Thefollowing table shows the gross unrealized losses and fair value of the Company’sinvestments with unrealized losses that are not deemed to beother-than-temporarily impaired, aggregated by investment category and lengthof time that individual securities have been in a continuous unrealized lossposition, at March 31, 2010 (in thousands):

 
| ** **                              | ** ** | **Less than 12 months** | ** ** | **12 months or greater**      | ** ** | **Total**      | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-------------------------------|------------|----------------|------------|
| **U.S. Debt Securities**                | ** ** | **Fair Value**          | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| U.S. Treasury securities                |       | $                       | 8,990      |                          | $          | (1             | )          | $ | — |   | $ | — |   | $ | 8,990 |   | $ | (1 | ) |
| U.S. government agency debt  securities |       | 15,065                  |       | (11                           | )          | —         |       | — |   | 15,065 |   | (11 | ) |
| Total available-for-sale                |       | $                       | 24,055     |                          | $          | (12            | )          | $ | — |   | $ | — |   | $ | 24,055 |   | $ | (12 | ) |

 

The gross unrealized losses above werecaused by interest rate increases. No significant facts or circumstances havearisen to indicate that there has been any deterioration in thecreditworthiness of the issuers of the Company’s securities. Based on theCompany’s review of these securities, including the assessment of the durationand severity of the unrealized losses and the Company’s ability and intent tohold the investments until maturity, there were no materialother-than-temporary impairments for these securities at March 31, 2010.

 

Fairvalue is defined as the exchange price that would be received for an asset orpaid to transfer a liability (an exit price) in the principal or mostadvantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date. Valuation techniques usedto measure fair value must maximize the use of observable inputs and minimizethe use of unobservable inputs.

 

TheCompany utilizes the following fair value hierarchy based on three levels ofinputs:

 

·                  Level1: Quotedprices in active markets for identical assets or liabilities.

 

·                  Level2: Inputsother than Level 1 that are observable, either directly or indirectly, such asquoted prices for similar assets or liabilities; quoted prices in markets thatare not active; or other inputs that are observable or can be corroborated byobservable market data for substantially the full term of the assets orliabilities.

 

·                  Level3: Unobservableinputs that are supported by little or no market activity and that aresignificant to the fair value of the assets or liabilities.

 

The following tablerepresents the Company’s fair value hierarchy for its financial assets measuredat fair value on a recurring basis as of March 31, 2010 (in thousands):

 
| ** **                             | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds                     |       | $           | 4,136      |        | $          | —      |       | $         | —     |   | $ | 4,136 |   |
| U.S. corporate debt securities         |       | —      |       | 3,001       |       | —      |       | 3,001     |       |
| U.S. government agency debt securities |       | —      |       | 28,074      |       | —      |       | 28,074    |       |
| U.S. Treasury securities               |       | —      |       | 32,976      |       | —      |       | 32,976    |       |
| Total                                  |       | $           | 4,136      |        | $          | 64,051      |       | $         | —     |   | $ | 68,187 |   |

 

The following tablerepresents the Company’s fair value hierarchy for its financial assets measuredat fair value on a recurring basis as of December 31, 2009 (in thousands):

 
| ** **                             | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds                     |       | $           | 21,186     |        | $          | —      |       | $         | —     |   | $ | 21,186 |   |
| U.S. corporate debt securities         |       | —      |       | 7,901       |       | —      |       | 7,901     |       |
| U.S. government agency debt securities |       | —      |       | 25,045      |       | —      |       | 25,045    |       |
| U.S. Treasury securities               |       | —      |       | 21,992      |       | —      |       | 21,992    |       |
| Total                                  |       | $           | 21,186     |        | $          | 54,938      |       | $         | —     |   | $ | 76,124 |   |

 

There are no financialliabilities measured at fair value on a recurring basis as of March 31,2010 and December 31, 2009.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS(Continued)**

***(Unaudited)***

* *

**NOTE 3. NET LOSS PER COMMON SHARE**

 

Basic net loss per common share iscalculated based on the weighted-average number of shares of common stockoutstanding during the period. Diluted net loss per common share is calculatedbased on the weighted-average number of shares of common stock outstanding andother dilutive securities outstanding during the period, if dilutive. Thepotential dilutive shares of common stock resulting from the assumed exerciseof outstanding stock options and equivalents and the assumed exercise of thewarrants are determined under the treasury stock method. Shares used in thecomputation of net loss per common share are as follows:

 

| ** **                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| **(In thousands, except per share amounts)** | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Numerator for basic and  diluted shares::    |       |                                  |       |   |   |
| Net loss                                     |       | $                                     | (3,827     | ) | $ | (10,155 | ) |
| Denominator for basic and  diluted shares:   |       |                                  |       |   |   |
| Weighted-average common  shares outstanding  |       | 52,299                                |       | 51,208 |   |
| Basic and diluted net loss  per share        |       | $                                     | (0.07      | ) | $ | (0.20 | ) |

 

At March 31, 2010 and 2009, the total number of outstanding commonstock equivalents excluded from the loss per share computation was 5.6 millionand 6.5 million, respectively.

 

**NOTE 4. LICENSE AND COLLABORATIVEARRANGEMENTS**

 

***Abbott Products Inc. (formerly Solvay Pharmaceuticals, Inc.)***

 

In March 2010,Abbott Products Inc. (Abbott Products) submitted a New Drug Application (NDA)for DM-1796 to the U.S. Food and Drug Administration (FDA) for the management ofpost-herpetic neuralgia.

 

Effective January 2009,the Company entered into an exclusive license agreement with SolvayPharmaceuticals, Inc. (Solvay) granting Solvay exclusive rights to developand commercialize DM-1796 for pain indications in the United States, Canada andMexico. Abbott Products acquired the pharmaceutical business of Solvay in atransaction that closed in February 2010.

 

Pursuant to theagreement, Solvay paid the Company a $25.0 million upfront fee in February 2009.The Company is also eligible to receive milestone payments for acceptance andFDA approval of the NDA for DM-1796 for post-herpetic neuralgia , and salesmilestone payments upon reaching certain sales milestones. Abbott Products isobligated to pay the Company royalties of 14 to 20 percent of net productsales, depending on the level of product sales.

 

TheCompany is recognizing the $25.0 million upfront payment ratably over theperiod of the Company’s development and supply obligations under the agreement,which is estimated to be through January 2013. For the three months ended March 31,2010, the Company recognized $1.6 million in license revenue under thearrangement. The remaining deferred revenue balance is $17.3 million as of March 31,2010.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS(Continued)**

***(Unaudited)***

* *

**NOTE 5. LONG-TERMDEBT**

 

In June 2008, the Company entered intoa loan and security agreement with General Electric Capital Corporation, asagent (GECC), and Oxford Finance Corporation (Oxford) that provided the Companywith a $15.0 million credit facility. The credit facility was available in upto three tranches. The first tranche of $3.8 million was advanced to theCompany upon the closing of the loan agreement. The second tranche of $5.6million was advanced to the Company in July 2008. The third tranche of$5.6 million was not drawn and is no longer available to the Company, and GECCand Oxford waived the 2% unused line fee related to the unused portion of thecredit facility.

 

The Company paid interest only on the firsttranche for the first six months at an interest rate of 11.59%. Beginning in January 2009,the Company began principal payments on the first tranche, plus interest atsuch rate, which will be paid in 30 equal monthly installments. The secondtranche was interest-only through December 31, 2008, with principal andinterest payable thereafter in 30 equal monthly installments at an interestrate of 11.59%. Interest expense, which includes amortization of debt issuancecosts, was $0.2 million for the three months ended March 31, 2010.

 

As of March 31, 2010, the outstandingbalance under the facility was $5.2 million, and the unamortized portion of thedebt issuance costs was approximately $0.2 million. Future contractualprincipal and interest payments are as follows (in thousands):

 

| ** **       | ** ** | **Principal** | ** ** | **Interest** | ** ** |
|------------------|------------|---------------|------------|--------------|------------|
| Less than 1 year |       | $             | 3,957      |         | $          | 400 |   |
| 1-2 years        |       | 1,209         |       | 27           |       |
| Total            |       | $             | 5,166      |         | $          | 427 |   |

 

The Company has the right to voluntarilyprepay debt outstanding under the facility, in full or in part. Upon anyvoluntary prepayment of any of the tranches, the Company will be required topay the lenders a prepayment premium equal to: (i) 5% on such prepaymentamount, if such prepayment is made within 14 months after the closing date, (ii) 4%on such prepayment amount, if such prepayment is made more than 14 months afterthe closing date but within 29 months after the closing date, and (ii) 3%on such prepayment amount, if such prepayment is made more than 29 months afterthe closing date, but on or before the maturity date of the respective tranche.

 

The obligations of the Company under theloan agreement are secured by interests in all of the Company’s personalproperty, and proceeds from any intellectual property, but not by the Company’sintellectual property.

 

Thecredit facility contains affirmative and negative covenants with which the Companymust comply with, and imposes restrictions with regards to additionalindebtedness, liens, various fundamental changes (including mergers andacquisitions), payments, investments, transactions with affiliates, and otherlimitations customary in secured credit facilities. The Company was incompliance with such covenants as of March 31, 2010.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS(Continued)**

***(Unaudited)***

* *

**NOTE6.  STOCK-BASED COMPENSATION**

 

The following table presents stock-basedcompensation expense recognized for stock options, stock awards and the Company’semployee stock purchase program (ESPP) in the Company’s statements ofoperations (in thousands):

 

| ** **                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **2010**                              | ** ** | **2009** | ** ** |
|                                         |       |                                  |       |   |   |
| Cost of sales                                |       | $                                     | 3          |   | $ | 9 |   |
| Research and development  expense            |       | 166                                   |       | 208 |   |
| Selling, general and  administrative expense |       | 376                                   |       | 477 |   |
| Total                                        |       | $                                     | 545        |   | $ | 694 |   |

 

At March 31, 2010, the Company had $2.9 millionof total unrecognized compensation expense, net of estimated forfeitures,related to stock option grants that will be recognized over an average vestingperiod of 2.4 years.

 

**NOTE7.  COMPREHENSIVE LOSS**

 

The following tablesummarizes components of total comprehensive loss (in thousands):

 

| ** **                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Net loss                                                 |       | $                                     | (3,827     | ) | $ | (10,155 | ) |
| Unrealized gain (loss) on  available-for-sale securities |       | —                                |       | (66 | ) |
| Total comprehensive loss                                 |       | $                                     | (3,827     | ) | $ | (10,221 | ) |

 

**NOTE8.  INVENTORIES**

 

Inventories relate to the manufacture ofthe Company’s GLUMETZA and Proquin XR products. Inventories are stated at thelower of cost or market and consist of the following (in thousands):

 

| ** **     | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------|------------|-------------------------|------------|----------------------------|------------|
| Raw materials  |       | $                       | 81         |                       | $          | 49 |   |
| Finished goods |       | 2,617                   |       | 2,453                      |       |
| Deferred costs |       | 62                      |       | 63                         |       |
| Total          |       | $                       | 2,760      |                       | $          | 2,565 |   |

 

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

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS(Continued)**

***(Unaudited)***

* *

**NOTE 9.   ACCOUNTS PAYABLE AND ACCRUED LIABILITIES**

 

Accountspayable and accrued liabilities consist of the following (in thousands):

 

| ** **                                     | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Accounts payable                               |       | $                       | 638        |                       | $          | 709 |   |
| Accrued compensation                           |       | 1,072                   |       | 2,404                      |       |
| Accrued clinical trial expense                 |       | 43                      |       | 221                        |       |
| Accrued rebates and sales discounts            |       | 3,198                   |       | 4,396                      |       |
| Allowance for product returns                  |       | 3,682                   |       | 3,364                      |       |
| Accrued promotion fee                          |       | 3,926                   |       | 1,752                      |       |
| Other accrued liabilities                      |       | 1,893                   |       | 2,376                      |       |
| Total accounts payable and accrued liabilities |       | $                       | 14,452     |                       | $          | 15,222 |   |

 

**NOTE10.  SHAREHOLDERS’ EQUITY**

 

***Option Exercises***

 

Forthe three months ended March 31, 2010, employees and consultants exercisedoptions to purchase 154,044 shares of the Company’s common stock with netproceeds to the Company of approximately $0.3 million.

 

**NOTE11.  INCOME TAXES**

 

As of December 31,2009 and March 31, 2010, the Company had $3.2 million of unrecognized taxbenefits, which is netted against deferred tax assets and is fully offset by avaluation allowance.  All tax years sinceinception remain open to examination by the Internal Revenue Service and theCalifornia Franchise Tax Board until such time the Company’s net operatinglosses and credits are either utilized or expire. Interest and penalties, ifany, related to unrecognized tax benefits, would be recognized as income taxexpense by the Company. The Company does not have any accrued interest orpenalties associated with unrecognized tax benefits.  The Company does not foresee any materialchanges to unrecognized tax benefits within the next twelve months.

 

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**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

### **FORWARD-LOOKINGINFORMATION**

### ** **

Statements made in this “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and elsewhere in this QuarterlyReport on Form 10-Q that are not statements of historical fact areforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended (the Securities Act), and Section 21Eof the Securities Exchange Act of 1934, as amended.  We have based these forward-lookingstatements on our current expectations and projections about futureevents.  Our actual results could differmaterially 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 toexpectations, projections or other characterizations of future events orcircumstances are forward-looking statements. Forward-looking statementsinclude, but are not necessarily limited to, those relating to:

 

·                  regulatoryfilings and approval of DM-1796 for postherpetic neuralgia;

 

·                  thecommercial success and market acceptance of DM-1796 if it is approved formarketing in the United States, and the efforts of Abbott Products Inc. (awholly-owned subsididary of Abbott Laboratories, or Abbott Products) withrespect to the commercialization of DM-1796;

 

·                  resultsand timing of our clinical trials, including the results of our SeradaTM Phase 3trial for menopausal hot flashes;

 

·                  thecommercial success and market acceptance of Serada if we receive approval tomarket Serada in the United States;

 

·                  thecommercial success of GLUMETZA® (metformin hydrochloride extended releasetablets) in the United States, and the efforts of Santarus, Inc.(Santarus) with respect to the commercialization of GLUMETZA;

 

·                  theresults of our ongoing litigation against Lupin Limited (Lupin) related toLupin’s abbreviated New Drug Application (ANDA) to market generic GLUMETZA inthe United States;

 

·                  theresults of our research and development efforts;

 

·                  submission,acceptance and approval of regulatory filings;

 

·                  ourneed for, and ability to raise additional capital;

 

·                  ourcollaborative partners’ compliance or non-compliance with their obligationsunder our agreements with them; and

 

·                  ourplans to develop other product candidates.

 

Factors that could cause actual results or conditionsto differ from those anticipated by these and other forward-looking statementsinclude those more fully described in the “**RISK FACTORS**”section and elsewhere in this Quarterly Report on Form 10-Q. Wedisclaim any intent to update or revise these forward-looking statements toreflect new events or circumstances.

 

**ABOUT DEPOMED**

 

Depomed is a specialtypharmaceutical company focused on the development and commercialization ofdifferentiated products that address large and growing markets and are based onproprietary oral drug delivery technologies. In 2009, we completed Phase 3 clinical trials for two productcandidates.  In October 2009, weannounced that DM-1796, an extended release formulation of gabapentin for thetreatment of postherpetic neuralgia that we have licensed to Abbott Productsmet its Phase 3 clinical trial primary endpoint with statisticalsignificance.  A New Drug Application(NDA) for DM-1796 was filed with the FDA in March 2010. Also in October 2009,we announced the results of Breeze 1 and Breeze 2, our Phase 3 clinical trialsfor Serada, our proprietary extended release formulation of gabapentin for thetreatment of menopausal hot flashes.  Thehigher dose formulation of Serada evaluated in the studies met five of eightco-primary endpoints across the two studies, while the lower dose formulationevaluated met four of eight co-primary endpoints. In December 2009, we metwith the FDA to discuss the results of the Breeze 1 and Breeze 2 studies andany additional clinical development that may be required to obtain approval tomarket Serada in the United States. We expect to initiate one additional Phase3 trial for Serada after we reach an agreement with the FDA on a Special ProtocolAssessment (SPA) for the trial.

 

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We seek to optimize theuse and value of our product candidates and drug delivery technologies in threeways.  First, we are seeking to assemblea number of pharmaceutical products that can be highly differentiated fromimmediate release versions of the compounds upon which they are based and maybe promoted together within a specialty pharmaceutical field, such as women’shealth care providers. Our development of Serada, and our retention ofco-promotion rights within the obstetrics/gynecology field in ourcommercialization arrangements with Covidien, Ltd. (Covidien) and Santarus, Inc.(Santarus), are examples of this aspect of our business strategy.  Second, we out-license product candidatesafter we have increased their value through our formulation and clinicaldevelopment efforts. Our DM-1796 license and development arrangement withAbbott Products is an example of this strategy. Third, we enter into collaborative partnerships with other companieswhere the unique capabilities of our technology can provide superior value to apartner’s product candidate, resulting in greater value for Depomed thantraditional fee-for-service arrangements. Our license and development arrangement with Covidien and our licenseagreement with Merck & Co., Inc. (Merck) are examples of thisstrategy.

 

We have developed twoproducts which have been approved by the FDA and are currently marketed.GLUMETZA is a once-daily treatment for adults with type 2 diabetes that wecommercialize in the United States with Santarus. Proquin® XR(ciprofloxacin hydrochloride) is a once-daily treatment for uncomplicatedurinary tract infections.

 

The following tablesummarizes our product pipeline and marketed products.

 

**ProductPipeline**

 
| **Product** | ** ** | **Indication**                   | ** ** | **Status**                                                                                                                                                         |
|-------------|------------|----------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| DM-1796     |       | Postherpetic  neuralgia          |       | Phase  3 study completed.

New  Drug Application submitted to the FDA in March 2010.

*Licensed  to Abbott Products in the United States, Mexico and Canada.* |
| SeradaTM    |       | Menopausal  hot flashes          |       | Phase  3 studies completed (Breeze 1 and Breeze 2).

One  additional Phase 3 study (Breeze 3) expected to be initiated in Q2 or Q3  2010.                          |
| DM-3458     |       | Gastroesophageal  reflux disease |       | Proof  of concept studies completed.                                                                                                                               |
| DM-1992     |       | Parkinson’s  disease        |       | Phase  1 study completed.

Second  Phase 1 study expected to be initiated in 2010.                                                                                 |

 

**Marketed Products**

 
| **Product**           | ** ** | **Indication**                         | ** ** | **Status**                                                                                                                                                                            |
|-----------------------|------------|----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| GLUMETZA®        |       | Type  2 diabetes                       |       | Currently  sold in the United States and Canada.

*Co-promoted  in the United States with Santarus.*

*Canadian  rights held by Biovail.*

*Korean  rights held by LG Life Sciences.* |
| Proquin® XR |       | Uncomplicated  urinary tract infection |       | Currently  sold in the United States.

Regulatory  application approved in Sweden*.*

*European  rights held by Rottapharm/Madaus*.                                                   |

 

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***Significant Developments and Highlights  for the Quarter Ended March 31, 2010***

 

·                  In March 2010, a NDA for DM-1796for the treatment of postherpetic neuralgia was filed with the Food &Drug Administration (FDA) by Abbott Products.

·                  Revenue for the three months ended March 31,2010 was $15.4 million, compared to $9.9 million for the three months ended March 31,2009.

·                  Operating expenses for the threemonths ended March 31, 2010 were $17.6 million, compared to $19.0 millionfor the three months ended March 31, 2009.

·                  Cash, cash equivalents and marketablesecurities were $71.5 million as of March 31, 2010, compared to $81.8million as of December 31, 2009.

 

**RECENT PRODUCT DEVELOPMENTS AND TRANSACTIONS**

 

## ***DM-1796 for Postherpetic Neuralgia***

## * *

*Abbott Products Inc.*  In November 2008, we entered into anexclusive license agreement with Solvay Pharmaceuticals, Inc. (Solvay)granting Solvay exclusive rights to develop and commercialize DM-1796 in theUnited States, Canada and Mexico for pain indications. The agreement becameeffective in January 2009, upon clearance of the transaction under the Hart-Scott-Rodino(HSR) Antitrust Improvements Act of 1976. Abbott Products acquired thepharmaceutical business of Solvay in a transaction that closed in February 2010.

 

In March 2010,Abbott Products submitted a New Drug Application (NDA) for DM-1796 to the U.S.Food and Drug Administration (FDA) for the management of postherpeticneuralgia.

 

Pursuant to the agreement, Solvay Pharmaceuticals paidus a $25 million upfront fee in February 2009. We are also eligible toreceive aggregate milestone payments of up to $70 million for acceptance andFDA approval of the New Drug Application for DM-1796 for PHN, and up to$300 million in potential sales milestone payments. Abbott Products willpay us royalties of 14 to 20 percent of net product sales, depending on thelevel of net product sales.

 

We remain responsible for certain other regulatorysupport activities through NDA approval. Abbott Products is responsible for NDA filing and has the option todevelop DM-1796 in further pain indications other than PHN.  If Abbott Products elects to develop DM-1796in fibromyalgia, we have a right of first negotiation for co-promotion rightsin the obstetrics/gynecology field upon fibromyalgia indication regulatoryapproval.

 

We are responsible for the manufacture of DM-1796 forup to four years from the effective date of the License Agreement, pursuant toa supply agreement to be entered into by Depomed and Abbott Products in 2010.The license agreement will expire with the last to expire of our patentscovering DM-1796, subject to early termination in certain circumstances.

 

## ***SeradaTM***** for Menopausal Hot Flashes**

 

*Phase 3 Study-Breeze 3 Clinical Trial. * In December 2009,the Company met with the FDA regarding Serada for the treatment of menopausalhot flashes. Based on guidance reflected in the meeting minutes, Depomed plansto conduct a single additional pivotal Phase 3 trial evaluating Serada for thetreatment of menopausal hot flashes. The company expects to initiate the trial,which will be known as Breeze 3, after it reaches agreement with the FDA on aSpecial Protocol Assessment (SPA) for the trial.

 

The Breeze 3 protocol hasbeen reviewed by the FDA under the FDA’s special protocol assessmentprocedures.  An SPA is an agreement with the FDA that a proposed trialprotocol design, clinical endpoints and statistical analyses are acceptable tosupport a product candidate’s regulatory approval.  We received an initialassessment of the Breeze 3 protocol in March 2010, and resubmitted the protocolfor a further assessment after modifying the protocol to address the FDA’sguidance reflected in the initial assessment.  On April 30, 2010, wereceived the FDA’s further guidance on the protocol.  The guidanceincluded three minor comments related to the statistical analysis of a secondaryendpoint, the Patient Global Impression of Change (PGIC).  The PGIC willbe used in conjunction with a “responder analysis” that may be required toassess the clinical meaningfulness of any reduction in the frequency of hotflashes in the active arm relative to the placebo arm.  Pursuant to SPAprocedures, we have requested a meeting with the FDA to reach final agreementon an SPA for Breeze 3.  We will begin enrolling patients as soon as wereceive FDA’s agreement, which we expect to occur by early July 2010.

 

*Study Design. *Breeze 3 will be a randomized, double-blind,placebo-controlled study of up to 600 patients. Patients will be randomizedinto one of two treatment arms, with patients receiving either placebo or atotal dose of 1800mg of Serada dosed 600mg in the morning and 1200mg in theevening. The co-primary efficacy endpoints in the study will be reductions inthe mean frequency of moderate-to-severe hot flashes, and the average severityof hot flashes, measured after four and 12 weeks of stable treatment. As in theprior Breeze 1 trial, the treatment duration of the study will be 24 weeks, toaddress the FDA’s view that an effective drug should also show statisticallysignificant persistence of efficacy at 24 weeks. The trial will also include a responderanalysis to assess the clinical meaningfulness of any reduction in thefrequency of hot flashes in the active arm relative to the placebo arm.

 

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Modifications to the design of Breeze 3 relative toBreeze 1 and 2 include: (i) a single active arm rather than two arms, andtherefore a required statistical p value of .05 rather than .025 to achievestatistical significance; (ii) up to 65% more patients in the activetreatment arm than in Breeze 1 and 2 (iii) a two-week run in period toprior to randomization, rather than one week, which is designed to reduce theregression to the mean observed in Breeze 1 and 2, resulting in a more stablebaseline, and thereby potentially reducing the placebo effect; and (iv) analternative statistical analysis method, known as a non-parametric analysis,that is designed to reduce the influence significant outliers can have on theachievement of efficacy endpoints.

 

**CRITICAL ACCOUNTING POLICIES**

 

Criticalaccounting policies are those that require significant judgment and/orestimates by management at the time that the financial statements are preparedsuch that materially different results might have been reported if otherassumptions had been made. We consider certain accounting policies related torevenue recognition, accrued liabilities and stock-based compensation to becritical policies. There have been no changes to our critical accountingpolicies since we filed our 2009 Annual Report on Form 10-K with theSecurities and Exchange Commission on March 9, 2010. For a description ofour critical accounting policies, please refer to our 2009 Annual Report on Form 10-K.

 

### **RESULTS OF OPERATIONS**

### ** **

*Three Months EndedMarch 31, 2010 and March 31, 2009*

* *

### **Revenue**

### ** **

Total revenues aresummarized in the following table (in thousands):

 

| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|
| ** **                               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Product sales:                           |       |                                  |       |   |   |
| GLUMETZA                                 |       | $                                     | 12,545     |   | $ | 6,643 |   |
| Proquin XR                               |       | 56                                    |       | 197 |   |
| Total product sales                      |       | 12,601                                |       | 6,840 |   |
|                                     |       |                                  |       |   |   |
| Royalties:                               |       |                                  |       |   |   |
| GLUMETZA                                 |       | 88                                    |       | 36 |   |
| Teva                                     |       | —                                |       | 428 |   |
| Total royalties                          |       | 88                                    |       | 464 |   |
|                                     |       |                                  |       |   |   |
| License and collaborative  revenue:      |       |                                  |       |   |   |
| DM-1796                                  |       | 1,561                                 |       | 1,477 |   |
| GLUMETZA                                 |       | 626                                   |       | 626 |   |
| Acuform technology                       |       | 458                                   |       | 458 |   |
| Proquin XR                               |       | 26                                    |       | 7 |   |
| Total license and  collaborative revenue |       | 2,671                                 |       | 2,568 |   |
|                                     |       |                                  |       |   |   |
| Total revenues                           |       | $                                     | 15,360     |   | $ | 9,872 |   |

 

***Productsales***

 

*GLUMETZA.*The increase inGLUMETZA product sales for the three months ended March 31, 2010 ascompared to the three months ended March 31, 2009 is primarily driven byincreased penetration in the metformin prescription market resulting from thepromotion efforts by our promotion partner, Santarus, and price increasesduring 2009 and the first quarter of 2010.

 

Product sales for GLUMETZA relative to its currentrunrate will depend in part on the success of our promotion partner, Santarus,as well any price adjustments.

 

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*Proquin XR*.  We defer recognition of revenue on productshipments of Proquin XR until the right of return no longer exists, whichoccurs at the earlier of the time Proquin XR units are dispensed throughpatient prescriptions or expiration of the right of return. At March 31,2010, we have a deferred revenue balance, which is classified as a liability onthe balance sheet, of $1.6 million associated with the deferral of revenueon Proquin XR product shipments, which is net of estimated wholesaler fees,retail pharmacy discounts, stocking allowances and prompt payment discounts.

 

In February 2009, we amended our promotionagreement with Watson, pursuant to which Watson performed a specified number ofdetails in the first quarter of 2009. The agreement with Watson terminated effective December 31, 2009,and we currently have no sales force or promotion partner promoting Proquin XRto physicians. Accordingly, we expect product sales for Proquin XR relative toits current runrate to decrease as a result of a decrease in promotionalefforts.

 

***Royalties***

 

*GLUMETZA**.* GLUMETZA royalties relate to royalties we receivedfrom Biovail based on net sales of GLUMETZA in Canada and royalties we receivedfrom 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 fromLG in the first quarter of 2007.

 

*Teva*. In April 2008, we entered into a settlement and license agreementwith Teva related to the patent infringement lawsuit against Teva affiliatesIVAX Corporation and IVAX Pharmaceuticals, Inc. we initiated in January 2006related to Teva’s generic Glucophage XR tablets. In connection with thesettlement and license agreement we were entitled to receive up to a total of$2.5 million in future royalties on Teva’s generic Glucophage XR product in theUnited States. The $2.5 million cap in royalties was met in 2009.

 

***Licenserevenue***

 

*DM-1796.*DM-1796 licenserevenue for the three months ended March 31, 2010 and 2009 relates to the$25.0 million upfront payment received from Solvay, now Abbott Products, underour license agreement granting Abbott Products exclusive rights to develop andcommercialize DM-1796 in the United States, Canada and Mexico for painindications. We are recognizing the $25.0 million upfront payment received fromSolvay as revenue ratably until January 2013, which represents theexpected maximum length of time our development and supply obligations existunder the agreement.

 

*GLUMETZA.*GLUMETZA licenserevenue for the three months ended March 31, 2010 and 2009 consisted oflicense revenue recognized from the $25.0 million upfront license fee receivedfrom Biovail in July 2005 and the $12.0 million upfront fee received fromSantarus in July 2008.

 

We are recognizing the $25.0 million upfront licensefee payment from Biovail as revenue ratably until October 2021, whichrepresents the estimated length of time our obligations exist under thearrangement related to royalties we are obligated to pay Biovail on net salesof GLUMETZA in the United States and for our obligation to use Biovail as oursole supplier of the 1000mg GLUMETZA. We are recognizing the $12.0 millionupfront payment from Santarus as revenue ratably until October 2021, whichrepresents the estimated length of time our obligations exist under thearrangement related to promotion fees we are obligated to pay Santarus forGLUMETZA in the United States.

 

*Acuform Technology**.***In November 2008, we entered into alicense agreement with Covidien granting Covidien worldwide rights to utilizeour Acuform technology for the exclusive development of four productscontaining acetaminophen in combination with opiates. Through November 2008,Covidien paid us a total of $5.5 million in upfront fees, representing a $4.0million upfront license fee and a $1.5 million upfront payment for formulationwork to be performed by Depomed under the agreement. The entire $5.5 million isbeing accounted for as a single unit of accounting and being amortized ratablythrough November 2011, which is the length of time Depomed is obligated toperform formulation work under the agreement.

 

**Cost of Sales**

 

Cost of sales consists of costs of the activepharmaceutical ingredient, contract manufacturing and packaging costs,inventory write-downs, product quality testing, internal employee costs relatedto the manufacturing process, distribution costs and shipping costs related toour product sales of GLUMETZA and Proquin XR. Total cost of sales for the threemonths ended March 31, 2010, as compared to the prior year, was as follows(in thousands):

 

| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Cost of sales |       | $                                     | 1,481      |   | $ | 1,032 |   |
|               |            |                                       |            |  |  |  |  |

 

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Cost of sales for the three months ended March 31,2010 and 2009 relates primarily to costs associated with the sale of GLUMETZAand Proquin XR. Cost of sales increased in 2010 as compared to the correspondingperiod in 2009 primarily as a result of an increase in GLUMETZA product sales.

 

The costs of manufacturing associated with deferredrevenue on Proquin XR product shipments are recorded as deferred costs, whichare included in inventory, until such time the related deferred revenue isrecognized.

 

**Researchand Development Expense**

 

Ourresearch and development expenses currently include costs for scientificpersonnel, supplies, equipment, outsourced clinical and other researchactivities, consultants, depreciation, facilities and utilities. The scope andmagnitude of future research and development expenses cannot be predicted atthis time for our product candidates in the early phases of research anddevelopment, as it is not possible to determine the nature, timing and extentof clinical trials and studies, the FDA’s requirements for a particular drugand the requirements and level of participation, if any, by potential partners.As potential products proceed through the development process, each step istypically more extensive, and therefore more expensive, than the previous step.Success in development therefore, generally results in increasing expendituresuntil actual product launch.

 

Totalresearch and development expense for the three months ended March 31,2010, as compared to the prior year, was as follows (in thousands):

 

| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Research and development  expense  |       | $                                     | 5,187      |   | $ | 10,021 |   |
| Dollar change from prior  year     |       | (4,834                                | )          |   |   |
| Percentage change from  prior year |       | (48                                   | )%         |   |   |
|                                    |            |                                       |            |  |  |  |  |

 

The decrease in research and development expense forthe three months ended March 31, 2010 as compared to the three monthsended March 31, 2009 was primarily due to lower clinical researchorganization expenses related to the completion of our DM-1796 Phase 3 andSerada Breeze 1 and Breeze 2 Phase 3 programs in October 2009.

 

We plan to conduct a single additional pivotal Phase 3 trial evaluatingSerada for the treatment of menopausal hot flashes. The company expects toinitiate the trial, which will be known as Breeze 3, by the end of July 2010.As such, we expect research and development expense to increase from levelsreported for the three months ended March 31, 2010. While we expect tocontinue to incur significant research and development expenses resulting fromthe progress of Breeze 3, we expect total research and development expenses todecrease in 2010 from 2009 as a result of completion of the DM-1796 Phase 3clinical trial during 2009.

 

Wecategorize our research and development expense by project. The table belowshows research and development costs for our major clinical developmentprograms, as well as the expenses associated with all other projects in ourproduct pipeline.

 

| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|
| ** **                               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| DM-1796                                  |       | $                                     | 1,377      |   | $ | 4,081 |   |
| Serada                                   |       | 1,948                                 |       | 3,575 |   |
| Other projects                           |       | 1,862                                 |       | 2,365 |   |
| Total research and  development expenses |       | $                                     | 5,187      |   | $ | 10,021 |   |

 

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**Selling, General and AdministrativeExpense**

 

Selling,general and administrative expenses primarily consist of personnel expenses tosupport our administrative and operating activities, marketing and promotionexpenses associated with Serada, GLUMETZA and Proquin XR, facility costs andprofessional expenses, such as legal and accounting fees. Total selling,general and administrative expenses, as compared to the prior year, were asfollows (in thousands):

 

| ** **                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
|                                               |       |                                  |       |   |   |
| Selling, general and  administrative expense:      |       |                                  |       |   |   |
| Promotion fee expense                              |       | $                                     | 8,879      |   | $ | 4,544 |   |
| Other selling, general and  administrative expense |       | 3,550                                 |       | 4,458 |   |
| Total selling, general and  administrative expense |       | $                                     | 12,429     |   | $ | 9,002 |   |
| Dollar change from prior  year                     |       | 3,427                                 |       |   |   |
| Percentage change from  prior year                 |       | 38                                    | %          |   |   |

 

The increase in selling,general and administrative expense was primarily due to an increase in GLUMETZApromotion fees to Santarus which was driven by an increase in GLUMETZA grossmargin. The increase in promotion fee expense was partially offset by adecrease in other expenses due to lower headcount in 2010.

 

**Interest Income and Expense**

 

| ** **                     | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|
| **(in thousands)**             | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Interest and other income      |       | $                                     | 94         |   | $ | 314 |   |
| Interest expense               |       | (183                                  | )          | (285 | ) |
| Net interest income  (expense) |       | (89                                   | )          | 29 |   |
|                                |            |                                       |            |  |  |  |  |

 

Interest and other income decreased during the three months ended March 31,2010 as compared to the corresponding period in 2009 as a result of lowerinterest rates on our investments.

 

Interest expense relates to interest on the credit facility we enteredinto in June 2008 with General Electric Capital Corporation and OxfordFinance Corporation.

 

**LIQUIDITYAND CAPITAL RESOURCES**

** **

| **(in thousands)**                                | ** ** | **March 31,********2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| Cash, cash equivalents and  marketable securities |       | $                              | 71,475     |                        | $          | 81,759 |   |
|                                                   |            |                                |            |                             |            |  |  |

 

Sinceinception through March 31, 2010, we have financed our product developmentefforts and operations primarily from private and public sales of equitysecurities and from license and termination fees from collaborative and licensepartners.

 

In December 2006, we entered into a common stockpurchase agreement with Azimuth Opportunity, Ltd., pursuant to which Azimuth iscommitted to purchase, from time to time and at our sole discretion, up to thelesser of (a) $30.0 million of our common stock, or (b) 8,399,654shares of common stock. In August 2008, the agreement was amended and theterm of the agreement was extended until December 2010. Sales to Azimuthunder the agreement, if any, will be made at a price equal to the averageclosing price of our common stock over a given pricing period, minus a discountranging from approximately 3.8% to 6.4%, which varies based on a thresholdprice set by us. Upon each sale of the our common stock to Azimuth under theagreement, we have also agreed to pay Reedland Capital Partners a placement feeequal to approximately 1.1% of the aggregate dollar amount of common stockpurchased by Azimuth. Azimuth is not required to purchase our common stock whenthe price of our common stock is below $2 per share. As of March 31, 2010,we have not sold any common stock to Azimuth under this common stock purchaseagreement.

 

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InJune 2008, we entered into a credit facility with GECC and Oxford. Thecredit facility was available in up to three tranches.  The first tranche of $3.8 million wasadvanced to us upon the closing of the loan agreement.  In July 2008, we received the secondtranche of $5.6 million. The third tranche of $5.6 million was not drawn and itis no longer available to us, and GECC and Oxford waived the 2% unused line feerelated to the third tranche.

 

We paid interest only on the first tranchefor the first six months at an interest rate of 11.59%.  Thereafter we are required to pay principalon the first tranche, plus interest at such rate, in 30 equal monthly installments.The second tranche was interest-only through December 31, 2008, withprincipal and interest payable thereafter in 30 equal monthly installments withan interest rate of 11.59%. As of March 31, 2010, the entire outstanding balance onthe credit facility was $5.2 million at an interest rate of 11.59%.

 

Our obligations under the loan agreement are secured by interests inall of our personal property, and proceeds from any intellectual property, butnot by our intellectual property.  Theloan agreement contains conditions precedent that must be satisfied prior toany borrowing and affirmative and negative covenants with which we mustcomply.  The loan agreement imposes restrictions with regards toadditional indebtedness, liens, various fundamental changes (including mergersand acquisitions), payments, investments, transactions with affiliates, andother limitations customary in secured credit facilities.  As of March 31, 2010, we were incompliance with such covenants. The loan agreement provides that events ofdefault will exist in certain circumstances, including failure to make paymentof principal or interest on the loans when required, failure to perform certainobligations under the loan agreement and related documents, defaults in certainother indebtedness and certain other events.  Upon an event of default,the principal amount of the loan may become due immediately.

 

Asof March 31, 2010, we have accumulated net losses of $176.0 million. Weexpect to continue to incur operating losses for the remainder of 2010. We anticipatethat our existing capital resources will permit us to meet our capital andoperational requirements through at least the end of 2011. We base thisexpectation on our current operating plan, which may change as a result ofmany factors.

 

Ourcash needs may also vary materially from our current expectations becauseof numerous factors, including:

 

·          sales of our marketed products;

·          expenditures related to our commercializationand development efforts, including arrangements we make for thecommercialization of Serada, if the product is approved for marketing;

·          financial terms of definitive licenseagreements or other commercial agreements we enter into, if any;

·          results of research and development efforts;

·          changes in the focus and direction of ourresearch and development programs;

·          technological advances;

·          results of clinical testing, requirements ofthe FDA and comparable foreign regulatory agencies; and

·          acquisitions or investment in complimentarybusinesses, products or technologies.

 

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

 

·          conduct research and development programs;

·          commercialize any products we market;

·          conduct preclinical and clinical testing; and

·          manufacture (or have manufactured) and market(or have marketed) our marketed products and product candidates.

 

Our existing capitalresources may not be sufficient to fund our operations until such time aswe may be able to generate sufficient revenues to support our operations.We have limited credit facilities and, except for the common stock purchaseagreement with Azimuth, we have no other committed sources of capital. To theextent that our capital resources are insufficient to meet our future capitalrequirements, we will have to raise additional funds through the sale of ourequity securities or from development and licensing arrangements to continueour development programs. We may be unable to raise such additionalcapital on favorable terms, or at all. If we raise additional capital byselling our equity or convertible debt securities, the issuance of suchsecurities could result in dilution of our shareholders’ equity positions. Ifadequate funds are not available we may have to:

 

·          delay, postpone or terminate clinical trials;

·          significantly curtail commercialization ofour marketed products or other operations; and/or

·          obtain funds through entering intocollaboration agreements on unattractive terms.

 

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The inability to raise additional capital required tofund our operations would have a material adverse effect on our company.

 

### **Cash Flows from OperatingActivities**

### ** **

Cash used in operating activities during the threemonths ended March 31, 2010 was approximately $9.6 million, compared tocash provided by operating activities of approximately $12.9 million for thethree months ended March 31, 2009. Cash used in operating activitiesduring the three months ended March 31, 2010 was primarily due to our netloss adjusted for movements in working capital, stock-based compensation anddepreciation expense. Cash provided by operating activities for the threemonths March 31, 2009 was primarily as a result of the $25.0 millionupfront payment received from Solvay in February 2009, offset by a netloss for the three months ended March 31, 2009.

 

**Cash Flows from Investing Activities**

 

Net cash used in investing activities during the threemonths ended March 31, 2010 was approximately $9.2 million and consistedprimarily of a net increase in marketable securities as a result of a shift inpurchasing slightly longer term securities. During the three months ended March 31,2010, the Company purchased more securities with original maturities greaterthan three months as compared to the fourth quarter of 2009, where purchases ofsecurities with original maturities under three months are classified as cashequivalents and not marketable securities. Net cash used in investingactivities during the three months ended March 31, 2009 was approximately$24.8 million and consisted primarily a net increase in marketable securitiesresulting from investment of the upfront payment received from Solvay in February 2009.

 

**Cash Flows from Financing Activities**

 

Cash used infinancing activities during the three months ended March 31,2010 was approximately $0.6 million compared to$0.7 million for the same period in 2009, and consisted of repayments ofprincipal on our credit facility offset by proceeds from employee andconsultant option exercises.

 

**Contractual Obligations**

 

As of March 31, 2010, our aggregate contractual obligations are asshown in the following table (in thousands):

 
| ** **                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Total** | ** ** |
|----------------------------|------------|-----------------------|------------|---------------|------------|---------------|------------|-----------|------------|
| Operating leases           |       | $                     | 1,613      |          | 1,370      |          | $          | —    |       | $ | 2,983 |   |
| Long-term debt (principal) |       | 3,957                 |       | 1,209         |       | —        |       | 5,166     |       |
| Long-term debt (interest)  |       | 400                   |       | 27            |       | —        |       | 427       |       |
| Purchase commitments       |       | 1,690                 |       | —        |       | —        |       | 1,690     |       |
|                       |       | $                     | 7,660      |          | $          | 2,606         |       | $         | —     |   | $ | 10,266 |   |
|                            |            |                       |            |               |            |               |            |           |            |  |  |  |  |

 

At March 31, 2010we had non-cancelable purchase orders and minimum purchase obligations ofapproximately $0.7 million under our manufacturing agreement with PatheonPuerto Rico, Inc. for the manufacture of 500mg GLUMETZA, and $1.0 millionunder our supply agreement with Biovail for the supply of 1000mg GLUMETZA. Theamounts disclosed only represent minimum purchase requirements. Actualpurchases are expected to exceed these amounts.

 

The contractualobligations reflected in this table exclude $3.0 million of contingentmilestone payments we may be obligated to pay in the future under oursublicense agreement with PharmaNova. The payments relate to various milestonesfor the product candidate under the sublicense agreement, including submissionto the FDA of an NDA, and FDA approval of an NDA. The above table also excludesany future royalty payments we may be required to pay on products we havelicensed or any promotion fees associated with our promotion agreement withSantarus.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

There have been nosignificant changes in our market risk compared to the disclosures in Item 7Aof our Annual Report on Form 10-K for the year ended December 31,2009.

 

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**ITEM 4. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

An evaluation was performed under the supervision andwith the participation of our management, including the Company’s ChiefExecutive Officer and Vice President, Finance, of the effectiveness of thedesign and operation of our disclosure controls and procedures as of the end ofthe period covered by this quarterly report. Based on that evaluation, ourmanagement, including the Company’s Chief Executive Officer and Vice President,Finance, concluded that our disclosure controls and procedures were effective.

 

We review and evaluate thedesign and effectiveness of our disclosure controls and procedures on anongoing basis to improve our controls and procedures over time and to correctany deficiencies that we may discover in the future. Our goal is to ensurethat our senior management has timely access to all material financial andnon-financial information concerning our business. While we believe the presentdesign of our disclosure controls and procedures is effective to achieve ourgoal, future events affecting our business may cause us to significantlymodify our disclosure controls and procedures.

 

***Changes in Internal Controls***

 

There were no changes inour internal controls over financial reporting during the quarter ended March 31,2010 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

***Depomed v. Lupin  (U.S.  Generic GLUMETZA Litigation)***

 

In November 2009, we filed a lawsuit againstLupin for infringement of the patents listed in the Orange Book for the ourGLUMETZA product. The lawsuit is in response to an Abbreviated New DrugApplication filed by Lupin with the FDA regarding Lupin’s intent to marketgeneric versions of 500mg and 1000mg dosage strengths of GLUMETZA prior to theexpiration of the four listed patents (U.S. Patent Nos. 6,340,475; 6,488,962;6,635,280; and 6,723,340). The Company has commenced the lawsuit within the45 days required to automatically stay, or bar, the FDA from approvingLupin’s ANDA for 30 months or until a district court decision that isadverse to the patents, whichever may occur earlier. An adverse outcome in thismatter could substantially weaken our U.S. intellectual property.

 

***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 seekingapproval to market a generic version of the 500mg formulation of GLUMETZA inCanada.

 

In February 2010, Apotex received clearance fromthe Minister of Health in Canada to market the generic version of the 500mgformulation of GLUMETZA.  Also in February 2010,Biovail and Depomed filed a complaint in the Federal Court in Canada againstApotex for infringement of the Company’s Canadian Patent No. 2,290,624.

 

An adverse outcome in this matter could substantiallyweaken our Canadian intellectual property.

 

**ITEM 1A.RISK FACTORS**

 

The risk factors presentedbelow amend and restate the risk factors previously disclosed in our AnnualReport on Form 10-K for the year ended December 31, 2009.

 

The following factors, alongwith those described above under **“MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —LIQUIDITY AND CAPITAL RESOURCES”** should be reviewed carefully, inconjunction with the other information contained in this Report and ourfinancial statements. These factors, among others, could cause actual resultsto differ materially from those currently anticipated and contained inforward-looking statements made in this Form 10-Q and presented elsewhereby our management from time to time. See “Part I, Item 2—Forward-LookingInformation.”

 

**Wedepend on Abbott Products for certain aspects of the development andcommercialization of DM-1796, which subjects us to risks related to AbbottProducts and its business that are outside our control.**

 

Our license agreement with Abbott Products grants Abbott Productsexclusive rights to develop and commercialize DM-1796 in the United States,Canada and Mexico for pain indications. We depend on Abbott Products to obtain regulatory approval and completeany further development of DM-1796, and to commercialize the product in thelicensed territories, which subjects us to a number of risks, including thefollowing:

 

·                  we may not be able to controlthe amount and timing of resources that Solvay devotes to the development orcommercialization of DM-1796;

·                  we and Abbott Products may notbe successful in our efforts to obtain regulatory approval of DM-1796 in atimely manner, or at all;

·                  Abbott Products may experiencefinancial difficulties; or

·                  Abbott Products may change itsbusiness strategy, due to a combination with another company or for anotherreason unrelated to the DM-1796 commercial opportunity, in a manner thatadversely affects the development or commercialization of DM-1796.

 

Abbott completed itsacquisition of Solvay’s pharmaceutical business in February 2010.  Accordingly Abbott’s subsidiary, AbbottProducts, is now responsible for the DM-1796 license arrangement.  We do not yet know whether Abbott Productswill be as committed to the development and commercialization of DM-1796 asSolvay, or whether Abbott Products may sublicense some or all of itsobligations under the license agreement. However, it is possible that Abbott Products’s acquisition of Solvay’spharmaceutical business may adversely affect the development orcommercialization of DM-1796.

 

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**Ourprior clinical trials evaluating S****erada****TM**** ****for menopausal hot flashes failed tomeet all of their primary endpoints and there can be no assurance this productwill be approved for marketing.**

 

In October 2009, ourPhase 3 trials evaluating Serada for menopausal hot flashes failed to meet allof their primary endpoints.  In December 2009,we met and discussed with the FDA the results of the trials and any additionalclinical development that may be required to complete the program and obtainregulatory approval to market Serada in the United States. Based on theguidance from the meeting with the FDA, we expect to initiate an additionalPhase 3 trial for Serada by the end of July 2010.  The trial will be known as Breeze 3.   There can be no assurance the results of theBreeze 3 trial will demonstrate the product candidate is sufficiently safe andeffective to obtain approval for marketing.

 

We will incur significantadditional expenses and will not know for at least one to two years whether thedrug is safe and effective such that it could be approved for marketing.Clinical development is a long, expensive and uncertain process and is subjectto delays.  The positive or encouragingresults of prior clinical trial are not necessarily indicative of the resultswe will obtain in later clinical trials. Accordingly, our additional Phase 3 trial may not demonstrate thatSerada is effective for menopausal hot flashes. In addition, data obtained from pivotal clinical trials are susceptibleto varying interpretations, which could delay, limit or prevent regulatoryapproval.

 

Many other factors coulddelay or result in termination of our clinical trials, including:

 

·                  negative or inconclusive results;

·                  patient noncompliance with the protocol;

·                  adverse medical events or side effectsamong patients during the clinical trials;

·                  FDA inspections of our clinicaloperations; and

·                  real or perceived lack of effectiveness orsafety of the product candidate.

 

**Wedepend heavily on Santarus, Inc. for the successful commercialization ofGLUMETZA in the United States.**

 

In July 2008, we entered into a promotionagreement with Santarus, Inc. pursuant to which Santarus will promote GLUMETZAin the United States through its sales force beginning in the fourth quarter of2008. Under the agreement, in exchange for promotion fees, Santarus is requiredto market and promote GLUMETZA to physicians in the United States, to deliverannual detail calls to potential GLUMETZA prescribers, and to maintain a salesforce of a minimum size.  Although we have retained rights to promoteGLUMETZA to obstetricians/gynecologists, or ob/gyns, and to retain revenuesfrom incremental sales generated by ob/gyns we call upon, ob/gyns generally donot prescribe significant amounts of metformin products.  In addition, we do not have any immediateplans to establish a sales force, or contract with a third party to act as oursales force, for the purpose of exercising our GLUMETZA co-promotion rights.Accordingly, the success of the commercialization of GLUMETZA will depend inlarge part on Santarus’ marketing and promotion efforts.  Factors that may affect the success of ourpromotion arrangement with Santarus include the following:

 

·                  Santarus may acquire or develop alternative products;

·                  Santarus may pursue higher-priority programs, orchange the focus of its marketing programs;

·                  Santarus may in the future choose to devote fewerresources to GLUMETZA;

·                  GLUMETZA may fail to achieve greater marketacceptance;

·                  The outcome of our ongoing litigation against LupinLimited seeking to prevent Lupin from marketing a generic version of GLUMETZAin the United States;

·                  Santarus may experience financial difficulties; and

·                  Santarus may fail to comply with its obligations underour promotion agreement.

 

Any of the preceding factors could affect Santarus’ commitment to thecollaboration, which, in turn, could adversely affect the commercial success ofGLUMETZA.  Any failure to successfully commercialize GLUMETZA could have amaterial adverse effect on our business, financial conditions, results ofoperations and cash flows.

 

InApril 2010, Santarus announced that the U.S. District Court for the District ofDelaware ruled that five patents covering Santarus’ Zegerid® (omeprazole/sodiumbicarbonate) prescription products were invalid due to obviousness. The rulingmay have an adverse impact on Santarus, which may in turn have an adverseimpact on Santarus’ commitment to GLUMETZA sales and marketing efforts.

 

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**The timing and any potential negative outcome inthe ongoing patent litigation with Lupin could adversely affect our financialcondition and results of operations as it could result in the introduction ofgeneric products prior to the expiration of the patents for GLUMETZA, as wellas in significant legal expenses and diversion of management time.**

 

In November 2009, we filed a lawsuit in theUnited States District Court for the Northern District of California againstLupin for infringement of U.S. Patent Nos. 6,340,475; 6,488,962; 6,635,280; and6,723,340 listed in the Orange Book for GLUMETZA. The lawsuit is in response toan Abbreviated New Drug Application (ANDA) filed by Lupin with the FDAregarding Lupin’s intent to market generic versions of the 500mg and 1000mgstrengths of GLUMETZA prior to the expiration date of the asserted patents.

 

We commenced the lawsuit against Lupin within theapplicable 45 day period required to automatically stay, or bar, the FDAfrom approving Lupin’s ANDA for 30 months or until a district courtdecision that is adverse to the asserted patents, whichever may occur earlier.The 30-month stay expires in May 2012. If the litigation is still ongoingafter expiration of the applicable 30-month stay, the termination of the staycould result in the introduction of one or more products generic to GLUMETZAprior to resolution of the litigation.

 

Although we intend to vigorously defend and enforceour patent rights, we are not able to predict the timing or outcome of thelitigation. The court may render its decision at any time after the filing ofthe post-trial briefs, which may be before or after the expiration of the30-month stay. An adverse outcome in this litigation could result in one ormore generic versions of GLUMETZA being launched before the expiration of thelisted patents, which could adversely affect our ability to successfullyexecute our business strategy to maximize the value of GLUMETZA and wouldnegatively impact our financial condition and results of operations, includingcausing a significant decrease in our revenues and cash flows. Regardless ofhow the litigation is ultimately resolved, the litigation may be costly,time-consuming and distracting to management, which could have a materialadverse effect on our business.

 

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

 

We have the following programs in clinical development,or pending regulatory approval: DM-1796 for neuropathic pain and Serada formenopausal hot flashes, and DM-1992 for Parkinson’s.  We also have other product candidates inearlier stages of development.

 

Our own product candidates and those of ourcollaborative partners are subject to the risk that any or all of them may befound to be ineffective or unsafe, or otherwise may fail to receivenecessary regulatory clearances.  Additionally, clinical trial results inearlier trials may not be indicative of results that will be obtained insubsequent larger trials, as was the case with the Phase 3 trial for DM-1796for the treatment of postherpetic neuralgia that we completed in 2007, and withthe Phase 3 trials evaluating Serada for menopausal hot flashes we completed inOctober 2009.

 

We are unable to predict whether any of these productcandidates will receive regulatory clearances or be successfully manufacturedor marketed.  Further, due to theextended testing and regulatory review process required before marketingclearance can be obtained, the time frames for commercialization of anyproducts are long and uncertain.  Even ifthese other product candidates receive regulatory clearance, our productsmay not achieve or maintain market acceptance. Also, substantially all ofour product candidates use the Acuform technology.  If it is discovered that theAcuform technology could have adverse effects or other characteristicsthat indicate it is unlikely to be effective as a delivery system for drugs ortherapeutics, our product development efforts and our business would besignificantly harmed.

 

**We are expecting operating losses in the future.**

 

To date, we have recorded revenues from license fees,product sales, royalties, collaborative research and development arrangementsand feasibility studies.  For the threemonths ended March 31, 2010, we recorded total revenues of $15.4 millionand for the years ended December 31, 2009, 2008 and 2007, we recordedtotal revenues of $57.7 million, $34.8 million, and $65.6 million,respectively. For the three months ended March 31, 2010, we incurred a netloss of $3.8 million, and for the years ended December 31, 2009 and 2008we incurred net losses of $22.0 million and $15.3 million, respectively. Thetermination of our license agreement with Esprit in July 2007, includingthe accelerated recognition of previously deferred revenue under thearrangement, and termination fees received associated with the termination ofour promotion agreement with King resulted in our reaching profitability in2007. However, as we continue our research and development efforts, preclinicaltesting and clinical trial activities, we anticipate that we will incuroperating losses for the remainder of 2010. Therefore, we expect our cumulative losses to increase. These losses,among other things, have had, and we expect that they will continue to have, anadverse impact on our total assets, shareholders’ equity and working capital.

 

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**Our operating results may fluctuateand affect our stock price.**

 

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

 

·                  announcements and results regarding clinical trial results and plansfor our drug candidates, including DM-1796 and Serada;

·                  filings and other regulatory actions related to DM-1796, Serada and ourother product candidates;

·                  the degree of commercial success of GLUMETZA;

·                  adverse events related to our products, including recalls;

·                  interruptions of manufacturing or supply;

·                  the outcome of our patent infringement litigation against Lupin forGLUMETZA;

·                  developments concerning proprietary rights, including patents,infringement allegations and litigation matters;

·                  variations in revenues obtained from collaborative agreements,including milestone payments, royalties, license fees and other contractrevenues;

·                  decisions by collaborative partners to proceed or not to proceed withsubsequent phases of a collaboration or program;

·                  market acceptance of the Acuform technology;

·                  adoption of new technologies by us or our competitors;

·                  the introduction of new products by our competitors;

·                  manufacturing costs and difficulties;

·                  third-party reimbursement policies; and

·                  the status of our compliance with the provisions of the Sarbanes-OxleyAct of 2002.

 

As a result of these factors, our stock price maycontinue to be volatile and investors may be unable to sell their shares at aprice equal to, or above, the price paid. Additionally, any significant dropsin our stock price, such as the one we experienced following the announcementof our Serada Phase 3 trial results in October 2009, could give rise toshareholder lawsuits, which are costly and time consuming to defend against andwhich may adversely affect our ability to raise capital while the suits arepending, even if the suits are ultimately resolved our favor.

 

**Our collaborative arrangementsmay give rise to disputes over commercial terms, contract interpretationand ownership of our intellectual property and may adversely affect thecommercial success of our products.**

 

We currently have collaboration arrangements withAbbott Products, Santarus and Covidien. In addition, we have in the past and may in the future enter intoother collaborative arrangements, some of which have been based on lessdefinitive agreements, such as memoranda of understanding, material transferagreements, options or feasibility agreements. We may not execute definitive agreements formalizing thesearrangements.  Collaborativerelationships are generally complex and may give rise to disputesregarding the relative rights, obligations and revenues of the parties,including the ownership of intellectual property and associated rights andobligations, especially when the applicable collaborative provisions have notbeen fully negotiated and documented. Such disputes can delay collaborativeresearch, development or commercialization of potential products, and can leadto lengthy, expensive litigation or arbitration. The terms of collaborativearrangements may also limit or preclude us from developing products ortechnologies developed pursuant to such collaborations. Additionally, thecollaborators under these arrangements might breach the terms of theirrespective agreements or fail to prevent infringement of the licensed patentsby third parties. Moreover, negotiating collaborative arrangements often takesconsiderably longer to conclude than the parties initially anticipate, whichcould cause us to enter into less favorable agreement terms that delay or deferrecovery of our development costs and reduce the funding available to supportkey programs.

 

We may be unable to enter into futurecollaborative arrangements on acceptable terms, which would harm our ability todevelop and commercialize our current and potential future products. Further,even if we do enter into collaboration arrangements, it is possible that ourcollaborative partners may not choose to develop and commercializeproducts using the Acuform technology. Other factors relating tocollaborations that may adversely affect the commercial success of ourproducts include:

 

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·                  any parallel development by acollaborative partner of competitive technologies or products;

·                  arrangements with collaborativepartners that limit or preclude us from developing products or technologies;

·                  premature termination of acollaboration agreement; or

·                  failure by a collaborative partner todevote sufficient resources to the development and commercial sales of productsusing the Acuform technology.

 

Our collaborative arrangements do not necessarilyrestrict our collaborative partners from competing with us or restrict theirability to market or sell competitive products. Our current and any futurecollaborative partners may pursue existing or other development-stageproducts or alternative technologies in preference to those being developed incollaboration with us. Our collaborative partners may also terminate theircollaborative relationships with us or otherwise decide not to proceed withdevelopment and commercialization of our products.

 

**We have limited in-house sales andmarketing resources, which we will require in order to successfully promoteproducts through our own sales force.**

 

If Serada or another product we develop or acquire isapproved for marketing in the United States, we may choose to promote theproduct with our own sale force or through a contract sales organization. Wealso have rights to promote GLUMETZA through our own sales force, or throughthird parties, and we have retained co-promotion rights for certain productcandidates our collaborative partners may develop. We currently have no salesforce and limited marketing and sales staff. The success of our own promotion efforts for Serada, GLUMETZA and anyother product candidates that receive regulatory approval that we choose tomarket or co-market, will require that we substantially enhance our in-housemarketing and sales force with technical expertise, or make arrangements withthird parties to perform these services for us. The development of the infrastructure associated with these activitiesinvolves substantial resources, and considerable attention of our managementand key personnel. To the extent that we enter into marketing and salesarrangements with other companies, our revenues will depend on the efforts ofothers. These efforts may not be successful. If we fail to fully developmarketing and sales capabilities, or enter into arrangements with thirdparties, our revenues may suffer.

 

**We depend on our marketing partnersfor the successful commercialization of GLUMETZA in Canada and Korea, and ofProquin XR in Europe.**

 

We have licensed exclusive marketing rights to the500mg GLUMETZA in Canada to Biovail, and in Korea to LG Life Sciences.  Biovail launched the 500mg GLUMETZA in Canadain November 2005, and LG launched a 500mg product in Korea in 2006 underthe trade name Novamet GR.  We have alsoentered into a license agreement with Madaus, a company acquired by Rottapharmin June 2007, related to the commercialization of Proquin XR in Europe. Ifour international commercial partners fail to successfully commercializeproducts we have licensed to them, our future revenues may be adverselyaffected.

 

**Ourcredit facility contains operating covenants that may restrict our business andfinancing activities.**

 

We entered into a$15.0 million credit facility with Oxford Finance Corporation and GeneralElectric Capital Corporation in June 2008. We have drawn $9.4 million under the facility and will not make anyfurther draws under the facility. As of March 31, 2010, we have $5.2million of principal outstanding under the facility. The credit facility issecured by a pledge of all of our assets other than intellectual property, andcontains a variety of operational covenants, including limitations on ourability to incur liens or additional debt, make dispositions, pay dividends,redeem our stock, make certain investments and engage in certain merger,consolidation or asset sale transactions and transactions with affiliates,among other restrictions.  Any futuredebt financing we enter into may involve similar or more restrictive covenantsaffecting our operations.  Our borrowingsunder the credit facility or any future debt financing will need to be repaid,which creates additional financial risk for our company, particularly if ourbusiness, or prevailing financial market conditions, are not conducive topaying off or refinancing our outstanding debt obligations. Furthermore, ourfailure to comply with the covenants in the credit facility could result in anevent of default that, if not cured or waived, could result in the accelerationof all or a substantial portion of our debt, which could have a materialadverse effect on our cash position and significantly harm our business.

 

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

 

Our existing capitalresources may not be sufficient to fund our operations until such time as wemay be able to generate sufficient revenues to consistently support ouroperations.  We have limited creditfacilities and, except for our common stock 

 

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purchase agreement with Azimuth, we have no othercommitted sources of capital.  Anyadditional development of Serada for menopausal hot flashes or other clinicaldevelopment programs may require considerable financial resources, should wechoose to invest in those programs. To the extent that our capital resourcesare insufficient to meet our future capital requirements, in order to continueour development programs, we will have to raise additional funds through thesale of our equity securities, through debt financing, or from development andlicensing arrangements. We may be unable to raise such additional capital onfavorable terms, or at all. If we raise additional capital by selling ourequity or convertible debt securities, the issuance of such securities couldresult in dilution of our shareholders’ equity positions. If adequate funds arenot available we may have to:

 

·                  delay, postpone or terminate clinical trials;

·                  significantly curtail commercialization of ourmarketed products or other operations; and/or

·                  obtain funds through entering into collaborationagreements on unattractive terms.

 

**The global economic downturn mayadversely affect our business.**

 

The economic downturnthat has affected the global economy over the past several fiscal quarters mayhave a material adverse effect on our liquidity and financial condition and ourability to raise additional funds, whether pursuant to our existing or futurefinancing arrangements.  In addition, if these developments negativelyimpact the ability of our collaborative partners to develop, manufacture,promote or commercialize our products and product candidates, our revenues maysuffer and our business, financial condition and results of operations could bematerially and adversely affected.  Similarly, any negative impact of aneconomic downturn or recession on our potential collaborative partners couldadversely affect the terms on which collaborative partnerships may be availableto us, if at all.

 

**Wemay be unable to protect our intellectual property and may be liablefor infringing the intellectual property of others.**

 

Our success will depend in part on our ability to obtain and maintainpatent protection for our products and technologies, and to preserve our tradesecrets.  Our policy is to seek toprotect our proprietary rights, by, among other methods, filing patentapplications in the United States and foreign jurisdictions to cover certainaspects of our technology. We currently hold thirteen issued United Statespatents, and have fifteen patent applications pending in the United States. In addition, we are preparing patent applications relating to our expandingtechnology for filing in the United States and abroad.  We have alsoapplied for patents in numerous foreign countries. Some of those countries havegranted our applications and other applications are still pending. Our pendingpatent applications may lack priority over others’ applications or may notresult in the issuance of patents. Even if issued, our patents may not besufficiently broad to provide protection against competitors with similartechnologies and may be challenged, invalidated or circumvented, which couldlimit our ability to stop competitors from marketing related products or maynot provide us with competitive advantages against competing products. We alsorely on trade secrets and proprietary know-how, which are difficult to protect.We seek to protect such information, in part, through entering intoconfidentiality agreements with employees, consultants, collaborative partnersand others before such persons or entities have access to our proprietary tradesecrets and know-how. These confidentiality agreements may not be effective incertain cases, due to, among other things, the lack of an adequate remedy forbreach of an agreement or a finding that an agreement is unenforceable. Inaddition, our trade secrets may otherwise become known or be independentlydeveloped by competitors.

 

Our ability to develop our technologies and to make commercial sales ofproducts using our technologies also depends on not infringing others’ patentsor other intellectual property rights. We are not aware of any intellectualproperty claims against us.  However, the pharmaceutical industry hasexperienced extensive litigation regarding patents and other intellectualproperty rights. For example, Pfizer has initiated several suits againstcompanies marketing generic gabapentin products, claiming that these productsinfringe Pfizer’s patents. The results of this litigation could adverselyimpact the commercialization of pharmaceutical products that contain gabapentinas an active pharmaceutical ingredient.  Also, patents issued to thirdparties relating to sustained release drug formulations or particularpharmaceutical compounds could in the future be asserted against us, althoughwe believe that we do not infringe any valid claim of any patents.  Ifclaims concerning any of our products were to arise and it was determined thatthese products infringe a third party’s proprietary rights, we could be subjectto substantial damages for past infringement or be forced to stop or delay ouractivities with respect to any infringing product, unless we can obtain alicense, or we may have to redesign our product so that it does not infringeupon others’ patent rights, which may not be possible or could requiresubstantial funds or time.  Such a license may not be available onacceptable terms, or at all.  Even if we, our collaborators or ourlicensors were able to obtain a license, the rights may be nonexclusive, whichwould give our competitors access to the same intellectual property.  Inaddition, any public announcements related to litigation or interferenceproceedings initiated or threatened against us, even if such claims are withoutmerit, could cause our stock price to decline.

 

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From time to time, we may become aware of activities by third partiesthat may infringe our patents.  Infringement by others of our patents mayreduce our market shares (if a related product is approved) and, consequently,our potential future revenues and adversely affect our patent rights if we donot take appropriate enforcement action.  We may need to engage in litigationin the future to enforce any patents issued or licensed to us or to determinethe scope and validity of third-party proprietary rights.  Our issued orlicensed patents may not be held valid by a court of competent jurisdiction.Whether or not the outcome of litigation is favorable to us, defending alawsuit takes significant time, may be expensive and may divert managementattention from other business concerns. We may also be required to participatein interference proceedings declared by the United States Patent and TrademarkOffice for the purpose of determining the priority of inventions in connectionwith our patent applications or other parties’ patent applications. Adversedeterminations in litigation or interference proceedings could require us toseek licenses which may not be available on commercially reasonable terms, orat all, or subject us to significant liabilities to third parties.  If weneed but cannot obtain a license, we may be prevented from marketing theaffected product.

 

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

 

Wehave an exclusive sublicense from PharmaNova, Inc. to a patent held by theUniversity of Rochester to develop and commercialize in the United States agabapentin product for the treatment of hot flashes associated withmenopause.  Because a method-of-usepatent, such as the patent we have sublicensed from PharmaNova, covers only aspecified use of a particular compound, not a particular composition of matter,we cannot prevent others from commercializing gabapentin.  Accordingly, physicians could prescribeanother manufacturer’s gabapentin to treat hot flashes in menopausal womenrather than Serada, or pharmacists could seek to fill prescriptions for Seradawith 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 andcostly.

 

**Itis difficult to develop a successful product. If we do not continue to developsuccessful products, our financial position and liquidity will be adverselyaffected.**

 

The drug development process is costly, time-consumingand subject to unpredictable delays and failures. Before we or others makecommercial sales of products using the Acuform technology, other thanGLUMETZA and Proquin XR, we, our current and any future collaborative partnerswill need to:

 

·                  conduct preclinical and clinical tests showing that these products aresafe and effective; and

·                  obtain regulatory approval from the FDA or foreign regulatoryauthorities.

 

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

 

·                  the Acuform technology has unintended or undesirable side effects;or

·                  product candidates that appear promising in preclinical or early-stageclinical studies do not demonstrate efficacy in later-stage, larger scaleclinical trials.

 

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

 

·                  market acceptance;

·                  cost-effective commercial scale production; and

·                  reimbursement under private or governmental health plans.

 

Any material delay or failure in the governmentalapproval process and/or the successful commercialization of our potentialproducts would adversely impact our financial position and liquidity.

 

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**If we do not achieve our projected development andcommercialization goals in the timeframes we announce and expect, thecommercialization of our product candidates may be delayed and our businesswill be harmed and our stock price may decline.**

 

For planning purposes, we sometimes estimate thetiming of the accomplishment of various scientific, clinical, regulatory andother product development and commercialization goals.  These milestones may include our expectationsregarding the commercial launch of our products by us or our licensees, and thecommencement or completion of scientific studies and clinical trials and thesubmission or approval of regulatory filings. From time to time, we may publicly announce the expected timing of someof these milestones, such as the completion of an ongoing clinical trial, theinitiation of other clinical programs, or the commercial launch ofproducts.  All of these milestones arebased on a variety of assumptions.  Theactual timing of these milestones can vary considerably from our estimatesdepending on numerous factors, some of which are beyond our control, including:

 

·                  the efforts of our marketing partnerswith respect to the commercialization of our products;

·                  the rate of progress, costs andresults of our clinical trial and research and development activities,including the extent of scheduling conflicts with participating clinicians andclinical institutions and our ability to identify and enroll patients who meetclinical trial eligibility criteria;

·                  our receipt of approvals by the FDAand other regulatory agencies and the timing thereof;

·                  other actions by regulators;

·                  our ability to access sufficient,reliable and affordable supplies of components used in the manufacture of ourproduct candidates, including materials for our Acuform technology;

·                  our available capital resources; and

·                  the costs of ramping up andmaintaining manufacturing operations, as necessary.

 

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

 

**We depend on clinical investigators and clinical sitesto enroll patients in our clinical trials and other third parties to manage thetrials 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 clinicalinvestigators and clinical sites to enroll patients and other third parties tomanage our trials and to perform related data collection and analysis. However,we may be unable to control the amount and timing of resources that theclinical sites that conduct the clinical testing may devote to our clinicaltrials.  If our clinical investigatorsand clinical sites fail to enroll a sufficient number of patients in ourclinical trials or fail to enroll them on our planned schedule, we will beunable to complete these trials or to complete them as planned, which coulddelay or prevent us from obtaining regulatory approvals for our productcandidates.

 

Our agreements withclinical investigators and clinical sites for clinical testing and for trialmanagement services place substantial responsibilities on these parties, whichcould result in delays in, or termination of, our clinical trials if theseparties fail to perform as expected. For example, if any of our clinical trialsites fail to comply with FDA-approved good clinical practices, we may beunable to use the data gathered at those sites. If these clinicalinvestigators, clinical sites or other third parties do not carry out theircontractual duties or obligations or fail to meet expected deadlines, or if thequality or accuracy of the clinical data they obtain is compromised due totheir failure to adhere to our clinical protocols or for other reasons, ourclinical trials may be extended, delayed or terminated, and we may be unable toobtain regulatory approval for, or successfully commercialize, our productcandidates.

 

**If we are unable to obtain or maintain regulatoryapproval, we will be limited in our ability to commercialize our products, andour business will be harmed.**

 

The regulatory process is expensive and timeconsuming. Even after investing significant time and expenditures on clinicaltrials, we may not obtain regulatory approval of our product candidates. Dataobtained from clinical trials are susceptible to varying interpretations, whichcould delay, limit or prevent regulatory approval, and the FDA may not agreewith our methods of clinical data analysis or our conclusions regarding safetyand/or efficacy. Significant clinical trial delays would impair our ability tocommercialize our products and could allow our competitors to bring products tomarket before we do. In addition, changesin regulatory policy for product approval during the period of productdevelopment and regulatory agency review of each submitted new application maycause delays or rejections. Even if we receive regulatory approval, thisapproval may entail limitations on the indicated uses for which we can market aproduct.

 

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For example, the active ingredients in the productsutilizing our Acuform delivery technology that are being developed pursuant toour collaboration with Covidien include acetaminophen in combination withopiates.  In connection with concernsthat consumers may inadvertently take more than the recommended daily dose ofacetaminophen, potentiallycausing liver damage, an FDA advisory committee has recommended that prescriptionproducts containing acetaminophen in combination with prescription analgesics(including opiates) should include black box warnings and/or be removed fromthe market.  The FDA is evaluating therecommendations and has indicated that such an evaluation will take sometime.  The FDA is not required to acceptadvisory committee recommendations. Covidien’s ability or willingness to develop and market the productssubject to our collaboration may be adversely affected by actions of the FDA inresponse to the advisory committee recommendations.

 

Further, with respect to our approved products, onceregulatory approval is obtained, a marketed product and its manufacturer aresubject to continual review. The discovery of previously unknown problems with aproduct or manufacturer may result in restrictions on the product, manufactureror 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 ManufacturingPractices (cGMP). Failure to comply with manufacturing regulations can resultin, 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 criminalprosecution.

 

**Pharmaceuticalmarketing is subject to substantial regulation in the United States.**

 

All marketing activities associated with GLUMETZA andProquin XR, as well as marketing activities related to any other products forwhich we obtain regulatory approval, will be subject to numerous federal andstate laws governing the marketing and promotion of pharmaceutical products.The FDA regulates post-approval promotional labeling and advertising to ensurethat they conform to statutory and regulatory requirements. In addition toFDA restrictions, the marketing of prescription drugs is subject to laws andregulations prohibiting fraud and abuse under government healthcare programs.For example, the federal healthcare program antikickback statute prohibitsgiving things of value to induce the prescribing or purchase of products thatare reimbursed by federal healthcare programs, such as Medicare and Medicaid.In addition, federal false claims laws prohibit any person from knowinglypresenting, or causing to be presented, a false claim for payment to thefederal government. Under this law, the federal government in recent years hasbrought claims against drug manufacturers alleging that certain marketingactivities caused false claims for prescription drugs to be submitted tofederal programs. Many states have similar statutes or regulations, which applyto 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 regulationsrelating to the marketing of our products, we could be subject to criminal prosecution,civil penalties, seizure of products, injunction, and exclusion of our productsfrom reimbursement under government programs, as well as other regulatoryactions against our product candidates, our collaborative partners or us.

 

**The approval process outside the United States isuncertain and may limit our ability to develop, manufacture and sell ourproducts internationally.**

 

To market any of our products outside of the UnitedStates, we and our collaborative partners, including Madaus, are subject tonumerous and varying foreign regulatory requirements, implemented by foreignhealth authorities, governing the design and conduct of human clinical trialsand marketing approval for drug products. The approval procedure varies amongcountries and can involve additional testing, and the time required to obtainapproval may differ from that required to obtain FDA approval. The foreignregulatory approval process includes all of the risks associated with obtainingFDA approval set forth above, and approval by the FDA does not ensure approvalby the health authorities of any other country, nor does the approval byforeign health authorities ensure approval by the FDA.

 

**If we or our marketing partners are unable to obtainacceptable prices or adequate reimbursement for our products from third-partypayers, we will be unable to generate significant revenues.**

 

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

 

·                  government health administrationauthorities;

·                  private health insurers;

 

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·                  health maintenance organizations;

·                  pharmacy benefit managementcompanies; and

·                  other healthcare-relatedorganizations.

 

If reimbursement is not available for our products orproduct candidates, demand for these products may be limited. Further, anydelay in receiving approval for reimbursement from third-party payers wouldhave an adverse effect on our future revenues. Third-party payers areincreasingly challenging the price and cost-effectiveness of medical productsand services. Significant uncertainty exists as to the reimbursement status ofnewly approved healthcare products, including pharmaceuticals. Our products maynot be considered cost effective, and adequate third-party reimbursement may beunavailable to enable us to maintain price levels sufficient to realize anacceptable return on our investment.

 

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

 

**Wemay be unable to compete successfully in the pharmaceutical product and drugdelivery system industries.**

 

Othercompanies that have oral drug delivery technologies competitive with theAcuform technology include Elan Corporation, Bristol-Myers Squibb, IVAXCorporation (a subsidiary of TEVA Pharmaceutical Industries, Ltd.), Johnson &Johnson, SkyePharma plc, Biovail Corporation, Flamel Technologies S.A., RanbaxyLaboratories, Ltd., Kos Pharmaceuticals, Inc., Intec Pharma and Alpharma, Inc.,all of which develop oral tablet products designed to release the incorporateddrugs over time. Each of these companies has patented technologies withattributes different from ours, and in some cases with different sites ofdelivery to the gastrointestinal tract.

 

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

 

Bayer Corporation developed a once-daily ciprofloxacinproduct for the treatment of urinary tract infections, which is currentlymarketed by Schering-Plough Corporation. There are also generic versions ofthat product on the market. There may be other companies developing productscompetitive with GLUMETZA and Proquin XR of which we are unaware.

 

Gabapentinis currently marketed by Pfizer as Neurontin for adjunctive therapy forepileptic seizures and for postherpetic pain. Pfizer’s basic U.S. patentsrelating to Neurontin have expired, and numerous companies have receivedapproval to market generic versions of the immediate release product. Inaddition, Pfizer has developed Lyrica® (pregabalin), which has been approvedfor marketing in the United States and the European Union.

 

Competitionin pharmaceutical products and drug delivery systems is intense. We expectcompetition to increase. Competing technologies or products developed in thefuture may prove superior to the Acuform technology or products usingthe Acuform technology, either generally or in particular market segments.These developments could make the Acuform technology or products using theAcuform technology noncompetitive or obsolete.

 

Mostof our principal competitors have substantially greater financial, sales,marketing, personnel and research and development resources than we do. Inaddition, many of our potential collaborative partners have devoted, andcontinue to devote, significant resources to the development of their own drugdelivery systems and technologies.

 

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

 

We are responsible for the supply and distribution ofGLUMETZA, and Patheon, Puerto Rico Inc. is our sole supplier for tablets of the500mg strength of GLUMETZA pursuant to a supply agreement we entered into withMOVA Pharmaceuticals in December 2006. Biovail is our sole supplier for the 1000mg formulation GLUMETZA.  We will be unable to manufacture GLUMETZA ina timely manner if we are unable to obtain GLUMETZA 500mg tablets from ourcontract manufacturer, active pharmaceutical ingredient from suppliers, orexcipient suppliers, or GLUMETZA 1000mg tablets from Biovail.

 

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We are also responsible for supply and distribution ofProquin XR.  For the manufacture ofProquin XR tablets, we have entered into an agreement with Patheon, Puerto Rico, Inc.,as our sole supplier. We purchase the active ingredient for Proquin XR fromUquifa Mexico, S.A., a sole supplier to us, on a purchase order basis. If weare unable, for whatever reason, to obtain the active pharmaceutical ingredientor Proquin XR tablets from our contract manufacturers, we may be unable tomanufacture Proquin XR in a timely manner, if at all.

 

Although we have obtained clinical batches of DM-1796and Serada from a contract manufacturer, we currently have no long-term supplyarrangement with respect to DM-1796 and Serada. Any failure to obtain clinical supplies of DM-1796 and Serada couldadversely affect these clinical development programs.

 

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

 

We do not have, and we do not intend to establish inthe foreseeable future, internal commercial scale manufacturing capabilities.Rather, we intend to use the facilities of third parties to manufactureproducts for clinical trials and commercialization. Our dependence on thirdparties for the manufacture of products using the Acuform technology mayadversely affect our ability to deliver such products on a timely orcompetitive basis.  The manufacturingprocesses of our third party manufacturers may be found to violate theproprietary rights of others. If we are unable to contract for a sufficientsupply of required products on acceptable terms, or if we encounter delays anddifficulties in our relationships with manufacturers, the market introductionand commercial sales of our products will be delayed, and our future revenuewill suffer.

 

**A successful product liability claim against uscould materially harm our business.**

 

Ourbusiness involves exposure to potential product liability risks that areinherent in the development and production of pharmaceutical products. We haveobtained product liability insurance for clinical trials currently underway andforecasted 2010 sales of our products, but:

 

·                  we may be unable to obtain product liability insurance for futuretrials;

·                  we may be unable to obtain product liability insurance for futureproducts;

·                  we may be unable to maintain product liability insurance onacceptable terms;

·                  we may be unable to secure increased coverage as thecommercialization of the Acuform technology proceeds; or

·                  our insurance may not provide adequate protection againstpotential liabilities.

 

Ourinability to obtain adequate insurance coverage at an acceptable cost couldprevent or inhibit the commercialization of our products. Defending a lawsuitwould be costly and significantly divert management’s attention from conductingour business. If third parties were to bring a successful product liabilityclaim or series of claims against us for uninsured liabilities or inexcess of insured liability limits, our business, financial condition andresults of operations could be materially harmed.

 

**Our success is dependent in large part upon thecontinued services of our CEO and senior management with whom we do not haveemployment agreements.**

 

Oursuccess is dependent in large part upon the continued services of our Presidentand Chief Executive Officer, Carl A. Pelzel, and other members of our executivemanagement team, and on our ability to attract and retain key management andoperating personnel. We do not have agreements with Mr. Pelzel or any ofour other executive officers that provide for their continued employment withus.  We may have difficulty filling opensenior scientific, financial and commercial positions. Management, scientificand operating personnel are in high demand in our industry and are oftensubject to competing offers. The loss of the services of one or more members ofmanagement or key employees or the inability to hire additional personnel asneeded could result in delays in the research, development andcommercialization of our products and potential product candidates.

 

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**If we choose to acquire new and complementarybusinesses, products or technologies, we may be unable to complete theseacquisitions or to successfully integrate them in a cost effective andnon-disruptive manner.**

 

Our success depends on our ability to continuallyenhance and broaden our product offerings in response to changing customerdemands, competitive pressures and technologies. Accordingly, we may in thefuture pursue the acquisition of complementary businesses, products ortechnologies instead of developing them ourselves. We have no currentcommitments with respect to any acquisition or such investment. We do not knowif we would be able to successfully complete any acquisitions, or whether wewould be able to successfully integrate any acquired business, product ortechnology or retain any key employees. Integrating any business, product ortechnology we acquire could be expensive and time consuming, disrupt ourongoing business and distract our management. If we were to be unable tointegrate any acquired businesses, products or technologies effectively, ourbusiness would suffer. In addition, any amortization or charges resulting fromthe costs of acquisitions could harm our operating results.

 

**We have implemented certainanti-takeover provisions.**

 

Certain provisions of our articles of incorporationand the California General Corporation Law could discourage a third party fromacquiring, or make it more difficult for a third party to acquire, control ofour company without approval of our board of directors. These provisions couldalso limit the price that certain investors might be willing to pay in thefuture for shares of our common stock. Certain provisions allow the board of directorsto authorize the issuance of preferred stock with rights superior to those ofthe common stock. We are also subject to the provisions of Section 1203 ofthe California General Corporation Law which requires a fairness opinion to beprovided to our shareholders in connection with their consideration of anyproposed “interested party” reorganization transaction.

 

We have adopted a shareholder rights plan, commonlyknown as a “poison pill”. The provisions described above, our poison pill andprovisions of the California General Corporation Law may discourage, delay orprevent a third party from acquiring us.

 

**Increased costs associated with corporate governancecompliance may significantly impact our results of operations.**

 

Changing laws, regulations andstandards relating to corporate governance, public disclosure and compliancepractices, including the Sarbanes-Oxley Act of 2002, new SEC regulations andNASDAQ Global Market rules, are creating uncertainty for companies such as oursin understanding and complying with these laws, regulations and standards.  As a result of this uncertainty and otherfactors, devoting the necessary resources to comply with evolving corporategovernance and publicdisclosure standards has resulted in and may in the future result in increasedgeneral and administrative expenses and a diversion of management time andattention to compliance activities.  Wealso expect these developmentsto increase our legal compliance and financial reporting costs.  In addition, these developments may make itmore difficult and more expensive for us to obtain director and officerliability insurance, and we may be required to accept reduced coverage or incursubstantially higher costs to obtain coverage. Moreover, we may be unable to comply with these new rules andregulations on a timely basis.

 

These developments could make it more difficult for usto attract and retain qualified members of our board of directors, or qualifiedexecutive officers.  We are presentlyevaluating and monitoring regulatory developments and cannot estimate thetiming 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.

 

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

 

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

 

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

 

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

 

**Business interruptions could limitour ability to operate our business.**

 

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

 

**ITEM 2.****    ****UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

Not applicable.

 

**ITEM 3.****    ****DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

**ITEM 4.****    ****RESERVED**

 

Not applicable.

 

**ITEM 5.****    ****OTHER INFORMATION**

 

Not applicable.

 

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**ITEM 6.EXHIBITS**

 
|   | (a)    | Exhibits |
|--------|--------|----------|
|   |   | 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  1934 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 |

 

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##### **SIGNATURES**

##### ** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
| Date:  May 3, 2010 | DEPOMED, INC.                     |
|-------------------------|----------------------------------------|
|                    |                                   |
|                    |                                   |
|                    | /s/ Carl A.  Pelzel                    |   |
|                    | Carl A. Pelzel                         |
|                    | President and Chief  Executive Officer |
|                    |                                   |
|                    |                                   |
|                    | /s/ Tammy L.  Cameron                  |   |
|                    | Tammy L. Cameron                       |
|                    | Vice President,  Finance               |

 

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