** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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, 2008**                                                                     |
|                                                                                                                        |                                                                                                    |
| **OR**                                                                                                                      |
|                                                                                                                        |                                                                                                    |
| **o**                                                                                                                       | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                        |                                                                                                    |
| **FOR THE TRANSITION PERIOD FROM         TO        ** |

 

**COMMISSION FILE NUMBER 000-23267**

 

**DEPOMED, INC.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITSCHARTER)

 

| **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, INCLUDINGAREA 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 |
|------------------|--------|-----------------|

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

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

 

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 May 5, 2008 was 48,027,047.

 

 

----

 

**DEPOMED, INC.**

 
| ** **                                                                                                                   | **PAGE**   |
|------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                                                                         |       |
| **PART I – FINANCIAL INFORMATION**                                                                                 | ** ** |
|                                                                                                                         |       |
| Item 1. Condensed  Consolidated Financial Statements:                                                                        |       |
|                                                                                                                         |       |
| Condensed Consolidated  Balance Sheets at March 31, 2008 (unaudited) and December 31, 2007                         | 3          |
|                                                                                                                         |       |
| Condensed Consolidated  Statements of Operations for the three month periods ended March 31,  2008 and 2007 (unaudited) | 4          |
|                                                                                                                         |       |
| Condensed Consolidated  Statements of Cash Flows for the three-month periods ended March 31,  2008 and 2007 (unaudited) | 5          |
|                                                                                                                         |       |
| Notes to Condensed  Consolidated Financial Statements                                                                        | 6          |
|                                                                                                                         |       |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations                         | 14         |
|                                                                                                                         |       |
| Item  3. Quantitative and Qualitative Disclosure About Market Risk                                                           | 24         |
|                                                                                                                         |       |
| Item  4. Controls and Procedures                                                                                             | 24         |
|                                                                                                                         |       |
| **PART II – OTHER  INFORMATION**                                                                                   | ** ** |
|                                                                                                                         |       |
| Item 1.  Legal Proceedings                                                                                                   | 25         |
|                                                                                                                         |       |
| Item 1A. Risk  Factors                                                                                                       | 25         |
|                                                                                                                         |       |
| Item  2. Unregistered Sales of Equity Securities and Use of Proceeds                                                         | 35         |
|                                                                                                                         |       |
| Item  3. Defaults upon Senior Securities                                                                                     | 35         |
|                                                                                                                         |       |
| Item  4. Submission of Matters to a Vote of Security Holders                                                                 | 35         |
|                                                                                                                         |       |
| Item 5.  Other Information                                                                                                   | 35         |
|                                                                                                                         |       |
| Item 6. Exhibits                                                                                                             | 36         |
|                                                                                                                         |       |
| Signatures                                                                                                                   | 37         |

 

2

----

 

**PART I – FINANCIAL INFORMATION**

 

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

###### ** **

**DEPOMED, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                                                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                      | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                                                                                                      | ** ** | **(Unaudited)**    | ** ** | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                      | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current  assets:                                                                                                                                                                                                                                                                |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                       |       | $                  | 11,592     |                  | $          | 14,374 |   |
| Marketable securities                                                                                                                                                                                                                                                           |       | 44,494             |       | 39,091                |       |
| Accounts receivable                                                                                                                                                                                                                                                             |       | 2,928              |       | 3,390                 |       |
| Unbilled accounts receivable                                                                                                                                                                                                                                                    |       | —             |       | 233                   |       |
| Inventories                                                                                                                                                                                                                                                                     |       | 2,206              |       | 3,263                 |       |
| Prepaid and other current assets                                                                                                                                                                                                                                                |       | 3,632              |       | 2,418                 |       |
| Total current assets                                                                                                                                                                                                                                                            |       | 64,852             |       | 62,769                |       |
| Marketable  securities                                                                                                                                                                                                                                                          |       | 7,598              |       | 16,058                |       |
| Property and  equipment, net                                                                                                                                                                                                                                                    |       | 1,413              |       | 1,621                 |       |
| Other assets                                                                                                                                                                                                                                                                    |       | 197                |       | 197                   |       |
|                                                                                                                                                                                                                                                                            |       | $                  | 74,060     |                  | $          | 80,645 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                                   | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current  liabilities:                                                                                                                                                                                                                                                           |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                                                |       | $                  | 1,046      |                  | $          | 1,134 |   |
| Accrued compensation                                                                                                                                                                                                                                                            |       | 949                |       | 1,558                 |       |
| Accrued clinical trial expense                                                                                                                                                                                                                                                  |       | 559                |       | 322                   |       |
| Other accrued liabilities                                                                                                                                                                                                                                                       |       | 3,262              |       | 3,322                 |       |
| Deferred product sales                                                                                                                                                                                                                                                          |       | 7,383              |       | 6,489                 |       |
| Deferred license revenue                                                                                                                                                                                                                                                        |       | 1,453              |       | 1,453                 |       |
| Other current liabilities                                                                                                                                                                                                                                                       |       | 56                 |       | 56                    |       |
| Total current liabilities                                                                                                                                                                                                                                                       |       | 14,708             |       | 14,334                |       |
| Deferred  license revenue, non-current portion                                                                                                                                                                                                                                  |       | 20,399             |       | 20,763                |       |
| Other  long-term liabilities                                                                                                                                                                                                                                                    |       | 55                 |       | 28                    |       |
| 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 outstanding at March 31, 2008 and  December 31, 2007, with an aggregate liquidation preference of $18,159 |       | 12,015             |       | 12,015                |       |
| Common stock, no par value, 100,000,000  shares authorized; 47,866,571 and 47,865,529 shares issued and outstanding at  March 31, 2008 and December 31, 2007, respectively                                                                                            |       | 168,912            |       | 168,287               |       |
| Accumulated deficit                                                                                                                                                                                                                                                             |       | (142,173           | )          | (134,892              | )          |
| Accumulated other comprehensive gain                                                                                                                                                                                                                                            |       | 144                |       | 110                   |       |
| Total shareholders’ equity                                                                                                                                                                                                                                                 |       | 38,898             |       | 45,520                |       |
|                                                                                                                                                                                                                                                                            |       | $                  | 74,060     |                  | $          | 80,645 |   |

 

----

(1) Derived from the audited consolidated financial statementsincluded in the Company’s Annual Report on Form 10-K for the year ended December 31,2007.

 

See accompanying notes to CondensedConsolidated Financial Statements.

 

3

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**DEPOMED, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                           | ** ** | **2008**                              | ** ** | **2007** | ** ** |
| Revenues:                                                                            |       |                                  |       |   |   |
| Product sales                                                                        |       | $                                     | 5,226      |   | $ | 1,332 |   |
| Royalties                                                                            |       | 112                                   |       | 34 |   |
| License revenue                                                                      |       | 363                                   |       | 2,463 |   |
| Total  revenues                                                                      |       | 5,701                                 |       | 3,829 |   |
|                                                                                 |       |                                  |       |   |   |
| Costs and  expenses:                                                                 |       |                                  |       |   |   |
| Cost of sales                                                                        |       | 1,209                                 |       | 306 |   |
| Research and development                                                             |       | 6,069                                 |       | 8,572 |   |
| Selling, general and administrative                                                  |       | 6,507                                 |       | 6,227 |   |
| Total costs  and expenses                                                            |       | 13,785                                |       | 15,105 |   |
|                                                                                 |       |                                  |       |   |   |
| Loss from  operations                                                                |       | (8,084                                | )          | (11,276 | ) |
|                                                                                 |       |                                  |       |   |   |
| Interest and  other income                                                           |       | 803                                   |       | 410 |   |
|                                                                                 |       |                                  |       |   |   |
| Net loss  before income taxes                                                        |       | (7,281                                | )          | (10,866 | ) |
|                                                                                 |       |                                  |       |   |   |
| Provision  for income taxes                                                          |       | —                                |       | — |   |
|                                                                                 |       |                                  |       |   |   |
| Net loss                                                                             |       | (7,281                                | )          | (10,866 | ) |
|                                                                                 |       |                                  |       |   |   |
| Deemed  dividend on preferred stock                                                  |       | (175                                  | )          | (167 | ) |
|                                                                                 |       |                                  |       |   |   |
| Net loss  applicable to common stock shareholders                                    |       | $                                     | (7,456     | ) | $ | (11,033 | ) |
|                                                                                 |       |                                  |       |   |   |
| Basic and  diluted net loss applicable to common stock shareholders per common share |       | $                                     | (0.16      | ) | $ | (0.26 | ) |
|                                                                                 |       |                                  |       |   |   |
| Shares used  in computing basic and diluted net loss per common share                |       | 47,866,093                            |       | 42,076,197 |   |

** **

See accompanying notes to CondensedConsolidated Financial Statements.

 

4

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**DEPOMED, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

** (in thousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| **Operating Activities**                                                     | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                                                    | (7,281     | ) | $ | (10,866 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                |       | 215                                                  |       | 226 |   |
| Employee and director stock-based  compensation                              |       | 552                                                  |       | 489 |   |
| Stock-based compensation related to  consultants                             |       | 69                                                   |       | 4 |   |
| Changes in assets and liabilities:                                           |       |                                                 |       |   |   |
| Accounts receivable                                                          |       | 695                                                  |       | 8,000 |   |
| Inventories                                                                  |       | 1,057                                                |       | 92 |   |
| Prepaid and other current assets                                             |       | (1,214                                               | )          | (505 | ) |
| Accounts payable and other accrued  liabilities                              |       | 116                                                  |       | (2,062 | ) |
| Accrued compensation                                                         |       | (609                                                 | )          | (602 | ) |
| Deferred revenue                                                             |       | 530                                                  |       | (2,763 | ) |
| Net cash (used in) operating activities                                      |       | (5,870                                               | )          | (7,987 | ) |
|                                                                         |       |                                                 |       |   |   |
| **Investing Activities**                                                     | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                          |       | (46                                                  | )          | (34 | ) |
| Purchases of marketable securities                                           |       | (22,202                                              | )          | (10,551 | ) |
| Maturities of marketable securities                                          |       | 24,350                                               |       | 8,994 |   |
| Sales of marketable securities                                               |       | 983                                                  |       | — |   |
| Net cash provided by (used in) investing  activities                         |       | 3,085                                                |       | (1,591 | ) |
|                                                                         |       |                                                 |       |   |   |
| **Financing Activities**                                                     | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Proceeds from issuance of common stock                                       |       | 3                                                    |       | 169 |   |
| Net cash provided by financing activities                                    |       | 3                                                    |       | 169 |   |
|                                                                         |       |                                                 |       |   |   |
| Net (decrease) in cash and cash equivalents                                  |       | (2,782                                               | )          | (9,409 | ) |
| Cash and cash equivalents at beginning of  period                            |       | 14,374                                               |       | 14,574 |   |
| Cash and cash equivalents at end of period                                   |       | $                                                    | 11,592     |   | $ | 5,165 |   |

 

See accompanying notes to CondensedConsolidated Financial Statements.

 

5

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**DEPOMED, INC.**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

## ***Basis of Presentation***

## * *

These unaudited condensed consolidated financialstatements and the related footnote information of Depomed, Inc. (theCompany or Depomed) have been prepared pursuant to the requirements of theSecurities and Exchange Commission (SEC) for interim reporting. As permittedunder those rules, certain footnotes or other financial information that arenormally required by U.S. generally accepted accounting principles have beencondensed or omitted pursuant to such rules and regulations. In theopinion of the Company’s management, the accompanying interim unauditedcondensed consolidated financial statements include all adjustments (consistingonly of normal recurring adjustments) necessary for a fair presentation of theinformation for the periods presented. The results for the interim period endedMarch 31, 2008 are not necessarily indicative of results to be expectedfor the entire year ending December 31, 2008 or future operating periods.

 

The balance sheet as of December 31, 2007 hasbeen derived from the audited financial statements at that date. The balancesheet does not include all of the information and footnotes required by U.S.generally accepted accounting principles for complete financial statements. Forfurther information, refer to the financial statements and footnotes theretoincluded in the Company’s annual report on Form 10-K for the year ended December 31,2007 filed with the SEC.

 

***Principles of Consolidation***

 

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

 

***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.

 

***Stock-BasedCompensation***

* *

Effective January 1, 2006, Depomed implementedthe provisions of Statement of Financial Accounting Standards No. 123(revised 2004), *Share-Based Payment* (FAS 123(R)),as interpreted by SEC Staff Accounting Bulletin No. 107 (SAB 107), using themodified prospective transition method. FAS 123(R) is a revision ofStatement of Financial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation*(FAS 123), and supercedes APB Opinion No. 25,*Accounting for Stock Issued to Employees*(APB No. 25).**FAS 123(R) requirescompanies to recognize the cost of employee and director services received inexchange for awards of equity instruments, based on the grant-date fair valueof those awards, in the statement of operations. Using the modified prospectivetransition method of FAS 123(R), Depomed began recognizing fair-valuecompensation expense for stock-based awards, including stock options grantedand purchase rights issued under its employee purchase plan after January 1,2006. Compensation expense for stock-based awards granted prior toimplementation that were unvested and outstanding as of January 1, 2006 isrecognized over the requisite service period based on the grant-date fair valueof those options and awards as previously calculated under FAS 123. Thecompensation expense for stock-based compensation is based on the single-optionapproach, includes an estimate for forfeitures and is recognized over thevesting term of the options using the straight-line method. FAS 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. Depomedestimates forfeitures based on historical experience.

 

6

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**DEPOMED, INC.**

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

***(Unaudited)***

 

On adoption of FAS 123(R), the Company concluded thatits historical share option exercise experience did not provide a reasonablebasis upon which to estimate expected term and estimated the expected term ofoptions granted by taking the average of the vesting term and the contractualterm of the option, as illustrated by the simplified method in SAB 107.  SAB 107 allowed for use of the simplifiedmethod to estimate expected term through December 31, 2007. In December 2007,the SEC issued SAB 110, which extended the ability for companies to utilize thesimplified method beyond December 31, 2007 under limitedcircumstances.  At January 1, 2008,the Company concluded again that its historical share option exerciseexperience did not provide a reasonable basis upon which to estimate expectedterm because of the Company’s limited exercise history and also elected to nolonger utilize the simplified method. For options granted after January 1, 2008, the Company hasestimated the expected term by using the weighted average terms of a peer groupof companies that grant options with similar vesting provisions.  The expected term used for options granted afterJanuary 1, 2008 is 5.04 years. See Note 4 of the Notes to CondensedConsolidated Financial Statements for further information regarding Depomed’sstock-based compensation expense.

* *

***Revenue Recognition***

 

The Company recognizes revenue from the sale of itsproducts, royalties earned and contract arrangements. Revenue arrangements withmultiple elements are divided into separate units of accounting if certaincriteria are met, including whether the delivered element has stand-alone valueto the customer and whether there is objective and reliable evidence of thefair value of the undelivered items. The consideration received is allocatedamong the separate units based on their respective fair values, and theapplicable revenue recognition criteria are applied to each of the separateunits.

 

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.

 

·      Product Sales - The Companysells GLUMETZA® and ProQuin® XR product to wholesalersand retail pharmacies that is subject to rights of return up to twelve monthsafter product expiration.  Given theCompany’s limited history of selling GLUMETZA and ProQuin XR, the Companycurrently cannot reliably estimate expected returns of the product at the timeof shipment. Accordingly, the Company defers recognition of revenue on productshipments of GLUMETZA and ProQuin XR until the right of return no longer exists,which occurs at the earlier of the time GLUMETZA and ProQuin XR units aredispensed through patient prescriptions or expiration of the right of return.The Company estimates patient prescriptions dispensed using an analysis ofthird-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 $7.4 million at March 31, 2008 related to GLUMETZA andProQuin XR product shipments that have not been recognized as revenue, which isnet of wholesaler fees, prompt payment discounts, chargebacks and Medicaidrebates. The Company will recognize revenue upon the earlier to occur ofprescription units dispensed or expiration of the right of return until it canreliably estimate product returns, at which time the Company will record aone-time increase in net revenue related to the recognition of revenuepreviously deferred. In addition, the costs of manufacturing GLUMETZA andProQuin XR associated with the deferred revenue are recorded as deferred costs,which are included in inventory, until such time the related deferred revenueis recognized.

 

·      ProductSales Allowances – The Company recognizes products sales allowances as areduction of product sales in the same period the related revenue isrecognized.

 

·      Wholesaler and Retail Pharmacy Discounts –The Company offers discounts to certain wholesale distributors and retailpharmacies based on contractually determined rates. The Company accrues thediscount on shipment to the respective wholesale distributors and retailpharmacies and recognizes the discount as a reduction of revenue in the sameperiod the related revenue is recognized.

 

·      Patient Support Programs – The Companyhas patient support programs in which patients receive co-pay assistance or afree limited supply of product from participating pharmacies.  The Company reimburses the pharmacies forthese discounts and the related reimbursement costs are accrued and treated asa reduction of revenue in the same period the related revenue is recognized.

 

7

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**DEPOMED, INC.**

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

***(Unaudited)***

 

·      Prompt Pay Discounts – The Company offerscash discounts to wholesaler distributors and retail pharmacies, generally 2%of the sales price, as an incentive for prompt payment. Based on the Company’sexperience, the Company expects the wholesaler distributors and retailpharmacies to comply with the contractual terms to earn the cash discount. TheCompany accounts for cash discounts by reducing accounts receivable by the fullamount and recognizes the discount as a reduction of revenue in the same periodthe related revenue is recognized.

 

·      Medicaid Rebates – The Companyparticipates in Medicaid rebate programs, which provide assistance to certaineligible low-income patients based on each individual state’s guidelinesregarding eligibility and services. Under the Medicaid rebate programs, theCompany pays a rebate to each participating state, generally two to threemonths after the quarter in which the prescription is filled. The Companyestimates and accrues Medicaid rebates based on third-party market dataregarding prescription payor information, historical usage, and changes in thelevel of discounts the Company offers that may affect the level of Medicaiddiscount.

 

·      Chargebacks – The Company providesdiscounts to authorized users of the Federal Supply Schedule (FSS) of theGeneral Services Administration under an FSS contract negotiated by theDepartment of Veterans Affairs.  Thesefederal entities purchase products from the wholesale distributors at adiscounted price, and the wholesale distributors then charge back to theCompany the difference between the current retail price and the price thefederal entity paid for the product.  TheCompany estimates and accrues chargebacks based on current contract prices andhistorical chargeback activity.

 

·      Royalties -Royalties are recognized as earned in accordance with the contract terms whenroyalties from licensees can be reliably measured and collectibility isreasonably assured. Royalties received under the Company’s agreements withBiovail Laboratories s.r.l. (Biovail) and LG Life Sciences (LG) are recognizedwhen the royalty payments are received as they are not estimable.

 

The Company recognizedroyalties under its license agreement with Esprit Pharma (Esprit) based onEsprit’s sales of ProQuin XR, net of any estimated returns, discounts, rebatesand chargebacks, subject to minimum annual royalties. The license agreementwith Esprit was terminated in July 2007.

 

·      License Revenue - Revenuefrom license arrangements is recognized when the Company has substantiallycompleted its obligations under the terms of the arrangement and the Company’sremaining involvement is inconsequential and perfunctory. If the Company hassignificant continuing involvement under such an arrangement, license fees arerecognized over the estimated performance period. License fee payments receivedin excess of amounts earned are classified as deferred revenue until earned.

 

·      Collaborative Revenue -Collaborative revenue recognized relates to services rendered in connectionwith collaborative arrangements and the achievement of milestones under sucharrangements. Revenue related to collaborative agreements with corporate partnersis recognized as the expenses are incurred under each contract. The Company isrequired to perform services as specified in each respective agreement andthe Company is reimbursed based on the costs incurred on each specificcontract. Nonrefundable substantive milestone payments are recognized pursuantto collaborative agreements upon the achievement of specified milestones whereno further obligation to perform exists under that milestone provision ofthe arrangement and when collectibility is reasonably assured.

 

***Recently Issued AccountingStandards***

 

InDecember 2007, the FASB ratified the final consensuses in Emerging IssuesTask Force (EITF) Issue No. 07-1, *Accountingfor Collaborative Arrangements* (EITF 07-1), which requirescertain income statement presentation of transactions with third parties and ofpayments between parties of the collaborative arrangement, along withdisclosure about the nature and purpose of the arrangement. EITF 07-1 iseffective for the Company beginning January 1, 2009. The Company does notexpect EITF 07-1 to have a material effect on its financial position, resultsof operations or cash flows.

 

8

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**DEPOMED, INC.**

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

***(Unaudited)***

 

EffectiveJanuary 1, 2008, the Company adopted EITF Issue No. 07-3, *Accounting for Nonrefundable Advance Payments for Goods or ServicesReceived for Use in Future Research and Development Activities*(EITF07-3). EITF 07-3 requires that nonrefundable advance payments for goods andservices that will be used or rendered in future R&D activities pursuant tocontractual arrangements be deferred and recognized as expense in the periodthat the related goods are delivered or services are performed. The adoption ofEITF 07-3 did not have a material impact on the Company’s financial position,results of operations or cash flows.

 

**NOTE 2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES**

 

 TheCompany considers all highly liquid investments with an original maturity (atdate of purchase) 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. The Company records cashequivalents at amortized cost, which approximates the fair value. Allmarketable securities are classified as available-for-sale since theseinstruments are readily marketable. These securities are carried at fair value,which is based on readily available market information, with unrealized gainsand losses included in accumulated other comprehensive loss within shareholders’equity. The Company uses the specific identification method to determine theamount of realized gains or losses on sales of marketable securities. Realizedgains or losses have been insignificant and are included in “interest and otherincome” in the condensed consolidated statement of operations. As of March 31,2008, the individual contractual period for all available-for-sale debtsecurities is less than two years.

 

The following tableshows the gross unrealized losses and fair value of the Company’s investmentswith unrealized losses that are not deemed to be other-than-temporarilyimpaired, aggregated by investment category and length of time that individualsecurities have been in a continuous unrealized loss position, at March 31,2008 (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.  government agency debt securities |       | $                       | —     |                          | $          | —         |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| U.S.  corporate debt securities         |       | 10,001                  |       | (61                           | )          | —         |       | — |   | 10,001 |   | (61 | ) |
| Total  available-for-sale               |       | $                       | 10,001     |                          | $          | (61            | )          | $ | — |   | $ | — |   | $ | 10,001 |   | $ | (61 | ) |

 

The grossunrealized losses above were caused by interest rate increases. No significantfacts or circumstances have arisen to indicate that there has been anydeterioration in the creditworthiness of the issuers of the Company’ssecurities. Based on the Company’s review of these securities, including theassessment of the duration and severity of the unrealized losses and theCompany’s ability and intent to hold the investments until maturity, there wereno material other-than-temporary impairments for these securities at March 31,2008.

 

Effective January 1,2008, the Company adopted Statementof Financial Accounting Standards No. 157, *Fair Value Measurements* (FAS 157). FAS 157 defines fairvalue, establishes a framework for measuring fair value under generally acceptedaccounting principles and enhances disclosures about fair value measurements.Fair value is defined under FAS 157 as the exchange price that would bereceived for an asset or paid to transfer a liability (an exit price) in theprincipal or most advantageous market for the asset or liability in an orderlytransaction between market participants on the measurement date. Valuationtechniques used to measure fair value under FAS 157 must maximize the use ofobservable inputs and minimize the use of unobservable inputs. The standarddescribes a fair value hierarchy based on three levels of inputs, of which thefirst two are considered observable and the last unobservable, that may be usedto measure fair value which are the following:

 

·      Level 1: Quoted prices in active markets for identical assets orliabilities.

·      Level 2: Inputs other than Level 1 that are observable, eitherdirectly or indirectly, such as quoted prices for similar assets orliabilities; quoted prices in markets that are not active; or other inputs thatare observable or can be corroborated by observable market data forsubstantially the full term of the assets or liabilities.

·      Level 3: Unobservable inputs that are supported by little or no marketactivity and that are significant to the fair value of the assets orliabilities.

 

9

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**DEPOMED, INC.**

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

***(Unaudited)***

 

Theadoption of FAS 157 did not have a material impact on the Company’s financialposition, results of operations or cash flows. In accordance with FAS 157, thefollowing table represents the Company’s fair value hierarchy for its financialassets measured at fair value on a recurring basis as of March 31, 2008(in thousands):

 
| ** **                              | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market  funds                     |       | $           | 402        |        | $          | —      |       | $         | —     |   | $ | 402 |   |
| Commercial  paper                       |       | —      |       | 9,968       |       | —      |       | 9,968     |       |
| U.S.  government agency debt securities |       | —      |       | 8,534       |       | —      |       | 8,534     |       |
| U.S.  corporate debt securities         |       | —      |       | 43,558      |       | —      |       | 43,558    |       |
| Total                                   |       | $           | 402        |        | $          | 62,060      |       | $         | —     |   | $ | 62,462 |   |

 

InFebruary 2007, the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities - Including anamendment of FASB Statement No. 115* (FAS 159), which provides afair value option election that permits entities to irrevocably elect tomeasure financial assets and liabilities (except for those that arespecifically scoped out of the Statement) at fair value as the initial andsubsequent measurement attribute, with changes in fair value recognized inearnings as they occur. FAS 159 permits the fair value option election on aninstrument-by-instrument basis at initial recognition of an asset or liabilityor upon an event that gives rise to a new basis of accounting for thatinstrument.  The Company did not elect to apply the fair value optionto any of its financial assets or liabilities; therefore, there has been noimpact on the Company’s financial position, results of operations or cashflows.

 

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

 

Net loss per common share is computed using theweighted-average number of shares of common stock outstanding. Common stockequivalent shares, which are based on the number of shares underlyingoutstanding stock options, warrants and other convertible securities, are not includedas their effect is antidilutive. At March 31, 2008 and 2007, the totalnumber of outstanding common stock equivalent shares excluded from the loss pershare computation was 8,842,590 and 8,550,392, respectively.

 

**NOTE 4.  STOCK-BASED COMPENSATION**

 

The following table presents stock-based compensationexpense recognized under FAS 123(R) for stock options, stock awards andthe Company’s employee stock purchase program (ESPP) in the Company’sconsolidated statements of operations (in thousands):

 
| ** **                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                  | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
|                                        |       |                                                 |       |   |   |
| Cost of sales                               |       | $                                                    | 5          |   | $ | 4 |   |
| Research and development expense            |       | 201                                                  |       | 201 |   |
| Selling, general and administrative expense |       | 415                                                  |       | 288 |   |
| Total                                       |       | $                                                    | 621        |   | $ | 493 |   |

 

At March 31, 2008, Depomed had $5.8 million oftotal unrecognized compensation expense, net of estimated forfeitures, relatedto stock option grants that will be recognized over an average vesting periodof 2.4 years.

 

10

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**DEPOMED, INC.**

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

***(Unaudited)***

 

**NOTE 5.  COMPREHENSIVE LOSS**

 

Total comprehensiveloss for the three months ended March 31, 2008 and 2007 approximates netloss and includes unrealized gains and losses on marketable securities.

 

**NOTE 6. INVENTORIES**

 

Inventories relateto the manufacture of the Company’s GLUMETZA and ProQuin XR products.Inventories are stated at the lower of cost or market and consist of thefollowing (in thousands):

 
| ** **      | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------|------------|------------------------------|------------|---------------------------------|------------|
| Raw materials   |       | $                            | 391        |                            | $          | 837 |   |
| Work-in-process |       | 229                          |       | 419                             |       |
| Finished goods  |       | 710                          |       | 1,184                           |       |
| Deferred costs  |       | 876                          |       | 823                             |       |
| Total           |       | $                            | 2,206      |                            | $          | 3,263 |   |

 

Deferred costsrepresent the costs of GLUMETZA and ProQuin XR product shipped for whichrecognition of revenue has been deferred.

 

**NOTE 7. SHAREHOLDERS’ EQUITY**

 

***Series A Preferred Stock***

 

InJanuary 2000, we issued 12,015 shares of Series A Preferred Stock at a price of$1,000 per share. The Series A Preferred Stock accrued a dividend of 7%per annum, compounded semi-annually and payable in shares of Series APreferred Stock. The Series A Preferred Stock was convertible at anytimebetween January 2002 and January 2006 into the Company’s commonstock. The original conversion price of the Series A Preferred Stock was$12.00; however, as a result of the Company’s March 2002 and October 2003financings, the conversion price had been adjusted to $9.51 per share. In December 2004,the Company entered into an agreement with the Series A Preferredshareholder to resolve a misunderstanding between the Company and theshareholder relating primarily to prior adjustments to the conversion price ofthe Series A Preferred Stock. Pursuant to the agreement, among othermatters, the Company agreed to adjust the conversion price to $7.50 per share.The Company and the shareholder also agreed to binding interpretations ofcertain other terms related to the Series A Preferred Stock conversionprice.

 

Priorto December 2004, the amounts calculated as Series A Preferred stockdividends were accounted for as an adjustment to the conversion price followingEITF Issue No. 98-5, *Accounting forConvertible Securities with Beneficial Conversion Features or ContingentlyAdjustable Conversion Ratios*(Issue No. 98-5).**As a result of the modifications to thepreferred stock agreement in December 2004, the Company determined that a “significantmodification” of the agreement had been made, and, therefore, a new “commitmentdate” for accounting purposes had been established on December 10, 2004.The Company measured the difference between the carrying value of the preferredstock and the fair value of the modified preferred stock pursuant to EITF TopicNo. D-42, *The Effect on the Calculationof Earnings per Share for the Redemption or Induced Conversion of PreferredStock* and determined that the fair value of the modified securitywas less than the carrying value of the security prior to the modification. TheCompany also evaluated the effective conversion rate, after considering thereset rate of $7.50 per share in addition to the common stock issuable uponconversion of the unpaid, accumulated dividends. The fair value of theunderlying common stock on December 10, 2004 was $5.06 per share. TheCompany determined that the conversion rate, after including the effect of theunpaid dividends, did not result in a beneficial conversion feature, whichcould have had the effect of also providing a deemed dividend to the preferredshareholder. However, an anti-dilutionprovision of the Series A Preferred Stock was triggered by the Company’s January 2005financing, which adjusted the conversion price of the Series A PreferredStock to $7.12. As a result of the adjusted conversion price and anincrease in the amount of common stock issuable upon conversion of the Series APreferred Stock due to additional accumulated dividends, the Series APreferred Stock now contains a “beneficial conversion feature” subject torecognition pursuant to Issue No. 98-5.

 

11

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**DEPOMED, INC.**

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

**(Unaudited)**

 

Inconjunction with the modification of the agreement, the Company issued awarrant to the Series A Preferred shareholder. The value of the warrantwas considered in determining the value of the modified security. The warrantis convertible into shares of the Company’s common stock during the periodbetween January 2006 and January 2009. The conversion price of thewarrant initially was $7.12, which was equal to the Series A PreferredStock conversion price in effect as of January 20, 2006. The conversionprice of the warrant decreases by approximately 4.8% per year during theconversion period, such that the number of shares of the Company’s common stockissuable upon conversion of the warrant will increase by approximately 5.1% peryear. The conversion of the warrant may be satisfied only by surrender of theoutstanding shares of Series A Preferred Stock.

 

TheSeries A Preferred Stock accrued dividends through January 20, 2006,which is the date the warrant initially became exercisable. As a result of theissuance of the warrant, the preferred stock may be surrendered in exchange forcommon stock for an additional three years through January 20, 2009. Aslong as the Series A Preferred Stock remains outstanding, the number ofshares into which the warrant can be converted increases as the conversionprice of the warrant decreases resulting in additional deemed dividends on the Series APreferred Stock. For the three months ended March 31, 2008 and 2007, theCompany recognized Series A Preferred Stock deemed dividends ofapproximately $175,000 and $167,000, respectively, attributable to thebeneficial conversion feature from the accrued dividends and decreasing warrantprice. The Company will continue to recognize Series A Preferred Stockdeemed dividends until the earlier of, the time the Series A PreferredStock is surrendered or until January 2009.

 

Asof March 31, 2008, there were 18,158 shares of Series A PreferredStock outstanding with an aggregate liquidation preference of approximately$18.2 million. The warrant was convertible into 2,842,650 shares of the Company’scommon stock at a conversion price of $6.39 as of March 31, 2008.

 

***Option Exercises***

 

Duringthe three months ended March 31, 2008, employees and consultants exercisedoptions to purchase 1,042 shares of the Company’s common stock with netproceeds to the Company of approximately $3,000.

 

**NOTE 8. RELATED PARTY TRANSACTIONS**

 

***John W. Fara, Ph.D.***

 

In August 2007, John W. Fara, Ph.D. retired from his positions asPresident, Chief Executive Officer and Chairman of the Company.  Dr. Fara will continue to serve as amember of the Company’s Board of Directors until the 2008 Annual Meeting.  The Company entered into a consulting agreementwith Dr. Fara, pursuant to which Dr. Fara will provide consultingservices to the Company through December 31, 2009. From August 2007through December 31, 2008, the Company will pay Dr. Fara $20,833 permonth for his consulting services, and will reimburse Dr. Fara for COBRAand life insurance premiums. Dr. Fara will be paid on an hourly basis forconsulting services provided in 2009. For the quarter ended March 31,2008, the Company incurred expense of approximately $62,000 associated withthis consulting agreement.

 

During the period of his consultancy, Dr. Fara will continue tovest in all of his currently unvested stock options, and his vested stockoptions will remain exercisable. For the quarter ended March 31, 2008, theCompany recognized approximately $59,000 in stock compensation expenseassociated with these awards. In the event of a change in control of theCompany, as defined by the Company’s 2004 Equity Incentive Plan, all of Dr. Fara’sunvested options will fully vest, and any remaining monthly payments forconsulting under the agreement will be accelerated.

 

12

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**DEPOMED, INC.**

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

**(Unaudited)**

 

***John F. Hamilton***

 

In October 2007, John F. Hamilton retired from his position asVice President, Finance and Chief Financial Officer of the Company.  The Company entered into a consultingagreement with Mr. Hamilton, pursuant to which Mr. Hamilton willprovide consulting services to the Company through October 10, 2008. From October 10,2007 through October 10, 2008, the Company will pay Mr. Hamilton$25,667 per month for his consulting services. For the quarter ended March 31,2008, the Company incurred expense of approximately $77,000 associated withthis consulting agreement. In the event of a change in control of the Company,as defined by the Company’s 2004 Equity Incentive Plan, any remaining monthlypayments for consulting under the agreement will be accelerated. The Companywill also reimburse Mr. Hamilton for COBRA premiums.

 

**NOTE 9. INCOME TAXES**

 

The Company adopted the provisions of FIN 48 on January 1,2007. As of December 31, 2007 and March 31, 2008, the Company had$2.9 million of unrecognized tax benefits, which is netted against deferred taxassets and is fully offset by a valuation allowance.  All tax years since inception remain open toexamination by the Internal Revenue Service and the California Franchise TaxBoard until such time the Company’s net operating losses and credits are eitherutilized or expire. Interest and penalties, if any, related to unrecognized taxbenefits, would be recognized as income tax expense by the Company. As of thedate of adoption of FIN 48, the Company did not have any accrued interestor penalties associated with unrecognized tax benefits.  The Company does not foresee any materialchanges to unrecognized tax benefits within the next twelve months.

 

**NOTE 10. SUBSEQUENT EVENTS**

 

***Settlement with TevaPharmaceuticals USA, Inc.***

 

In January 2006,the Company filed a complaint against IVAX Corporation (IVAX) in the U.S.District Court for the Northern District of California for infringement ofpatents related to the Company’s AcuForm delivery technology. Thecomplaint alleged infringement of the Company’s patents (US Patent Nos.6,340,475 and 6,635,280 (the “Asserted Patents”)) by IVAX’s extended releasemetformin hydrochloride tablets.

 

In April 2008, the Company entered intoa Settlement and License Agreement with Teva Pharmaceuticals USA, Inc.(Teva) related to the patent infringement lawsuit filed by the Company againstTeva affiliates IVAX Corporation and IVAX Pharmaceuticals, Inc. The settlementagreement provides for a one-time payment to the Company of $7.5 million, whichthe Company received in April 2008, and for a non-exclusive license to theAsserted Patents in favor of Teva (including IVAX) to continue to market itsgeneric Glucophage® XR (metformin hydrochloride extended releasetablets) product in the United States under the Asserted Patents.  TheCompany will also receive ongoing royalty payments from Teva on sales by Teva(including IVAX) of generic Glucophage XR in the United States.  Theroyalty is subject to a $2.5 million aggregate cap.

 

***Facilities in Menlo Park,California***

 

On April 22, 2008, the Company enteredinto amendments to its existing leases agreements with Menlo Business Park, LLCfor the Company’s premises at 1330, 1360 and 1430 O’Brien Drive, Menlo Park,California (the Lease Amendments). The Lease Amendments, effective as of March 18,2008, extend the term of the existing leases for thirty-one months, through January 31,2012, and provide for an option exercisable by the Company to further extendany of the lease terms for an additional five years.  All other material provisions of the leasesremain the same, except for the monthly base rent for the Company’s premises at1430 O’Brien Drive, which will be increased to $20,824 per month, beginning on July 1,2009, subject to adjustment under certain conditions, in addition to operatingexpenses and taxes for the duration of the lease term. The monthly base rentfor the Company’s premises at 1330 and 1360 O’Brien Drive did not change underthe Lease Amendments, and are $50,732 and $54,654 per month beginning May 1,2008, respectively, and subject to adjustment under certain conditions, inaddition to operating expenses and taxes for the duration of the lease term.

 

13

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

 

### **FORWARD-LOOKINGINFORMATION**

 

Statements made in this “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andelsewhere in this Quarterly Report on Form 10-Q that are not statements ofhistorical fact are forward-looking statements within the meaning of Section 27Aof the Securities 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-lookingstatements. Forward-looking statements are identified by words such as “believe,”“anticipate,” “expect,” “intend,” “plan,” “will,” “may” and other similarexpressions.  In addition, any statementsthat refer to expectations, projections or other characterizations of futureevents or circumstances are forward-looking statements. Forward-lookingstatements include, but are not necessarily limited to, those relating to:

 

·      thecommercial success and market acceptance of GLUMETZA® (metforminhydrochloride extended release tablets) in the United States;

·      ourability to find a commercialization partner for GLUMETZA;

·      ourability to find development and commercialization partners for Gabapentin GR®and other product candidates;

·      resultsand timing of our clinical trials, including the results of our Gabapentin GRtrials;

·      theresults of our internal research and development efforts;

·      acceptanceand approval of regulatory filings;

·      ourneed for, and ability to raise, additional capital;

·      marketacceptance of ProQuin® XR (ciprofloxacin hydrochloride extendedrelease tablets);

·      theefforts of Watson Pharmaceuticals with respect to the commercialization ofProQuin XR;

·      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 specialty pharmaceutical company focusedon the development and commercialization of differentiated products thataddress large and growing markets and are based on proprietary oral drugdelivery technologies.  In 2004, weannounced our determination to evolve from a solely product development focusedcompany to an integrated specialty pharmaceutical company, with sales andmarketing of our own products. Preliminary staffing for these activities began in 2005.  In 2006 and 2007, we enhanced our internalsales and marketing capabilities through the hiring of additional sales andmarketing employees and the engagement of consultants.

 

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

 

We have a three-pronged approach to productdevelopment designed to optimize the use and value of our drug deliverytechnologies, while managing the costs and risks associated with developing andcommercializing pharmaceutical products. We develop products for our ownaccount that are designed to compete in large growing markets and that can behighly differentiated from immediate release versions of the compounds uponwhich they are based. Second, we selectively enter into collaborativepartnerships with other companies where the unique capabilities of ourtechnology can provide superior 

 

14

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value to a partner’s compound, resulting insignificantly greater value for Depomed than a traditional fee-for-servicearrangement. Third, we enter into arrangements that enable our technology to beapplied by other companies to a greater number of compounds than ourinfrastructure can support, so as to derive additional value from ourtechnology. In the future, we plan to commercialize our proprietary products,relying on partners to cover the large primary care audiences, whilemaintaining co-promotion and distribution rights in order to be in a positionto create our own sales force when appropriate, thereby increasing the value tous of our products, and our control over them.

 

Our most advanced product candidate in development isGabapentin GR®, an extended release form of gabapentin.  With respect to Gabapentin GR, we havecompleted a Phase 2 clinical trial for the treatment of women with menopausalhot flashes.  We have also completed aPhase 3 clinical trial for the treatment of postherpetic neuralgia (PHN), andhave initiated a second Phase 3 trial for the same indication.  In addition, we have other product candidatesin earlier stages of development.

 

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

 

**Marketed Products**

 
| **Product**               | ** ** | **Indication**                        | ** ** | **Status  (1)**                                                                 |
|---------------------------|------------|---------------------------------------|------------|---------------------------------------------------------------------------------|
| GLUMETZA®            |       | Type 2 diabetes                       |       | Currently sold in the United States, Canada and  Korea.                         |
|                      |       |                                  |       | * *                                                                        |
|                      |       |                                  |       | *Canadian rights held by Biovail.  Korean rights held by LG Life Sciences.*     |
|                      |       |                                  |       |                                                                            |
| ProQuin® XR          |       | Uncomplicated urinary tract infection |       | Currently sold in the United States.*Co-promoted in the US with Watson Pharma.* |
|                      |       |                                  |       |                                                                            |
|                      |       |                                  |       | Regulatory application pending in Sweden. *European rights held by Rottapharm.* |
|                      |       |                                  |       |                                                                            |
| **Product  Pipeline**     |
|                      |       |                                  |       |                                                                            |
| Gabapentin GR®       |       | Postherpetic neuralgia                |       | Second Phase 3 study underway.                                                  |
|                      |       |                                  |       |                                                                            |
|                      |       | Menopausal hot flashes                |       | Phase 2 trial complete. Phase 3 study design  ongoing.                          |
|                      |       |                                  |       |                                                                            |
|                      |       | Diabetic peripheral neuropathy        |       | Phase 2 trial complete.                                                         |
|                      |       |                                  |       |                                                                            |
| Omeprazole                |       | Gastroesophageal reflux disease       |       | Phase 1a and Phase 2a proof of concept studies  completed.                      |
|                      |       |                                  |       |                                                                            |
| Undisclosed compound      |       | Confidential(2)                       |       | Phase 1 trial underway.                                                         |
|                      |       |                                  |       |                                                                            |
|                      |       |                                  |       | *Partnered with Supernus  Pharmaceuticals, Inc.*                           |
|                      |       |                                  |       |                                                                            |
| Two undisclosed compounds |       | Confidential                          |       | Preclinical development ongoing.                                                |
|                           |            |                                       |            |                                                                                 |  |  |  |  |

 

----

(1)    The sectionbelow entitled “Government Regulation” for additional information regarding thephases of drug development.

 

(2)    The compoundand indication may not be disclosed pursuant to the collaboration agreement.

 

Our intellectual property position includes nineissued patents and nineteen patent applications pending in the United States.

 

***Significant Developments for the Quarter Ended March 31,2008.***

 

·      In February 2008, weannounced positive results of our Phase 2 trial for Gabapentin GR for thetreatment of women with moderate-to-severe menopausal hot flashes.

 

15

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·      In February 2008, AbidRawn was appointed as our Vice President, Sales and Marketing.

·      In March 2008, weinitiated dosing of the first patient in a Phase 3 clinical trial forGabapentin GR for PHN.

·      Revenue for the three monthsended March 31, 2008 was $5.7 million, compared to $3.8 million for thethree months ended March 31, 2007.

·      Operating expenses for thethree months ended March 31, 2008 were $12.6 million compared to $14.8million for the three months ended March 31, 2007.

·      Cash, cash equivalents andmarketable securities were $63.7 million as of March 31, 2008 compared to$69.5 million as of December 31, 2007.

 

***Other Recent Developments***

 

·      In April 2008, weentered into a settlement and license agreement with Teva Pharmaceuticals USA, Inc.(Teva) related to our patent infringement lawsuit against Teva affiliates IVAXCorporation and IVAX Pharmaceuticals, Inc. In connection with the settlement and license agreement we received a$7.5 million payment and up to $2.5 million in future royalties on Teva’sgeneric Glucophage® XR (metformin hydrochloride extended releasetablets) product in the United States.

·      In April 2008, theBoard of the Directors of the Company appointed Karen A. Dawes to the Company’sBoard of Directors.

 

**RECENT PRODUCT DEVELOPMENTS**

 

***MARKETED PRODUCTS***

 

***GLUMETZA®***

 

*Contract Sales Organization*. In February 2008, we enteredinto a professional detailing services agreement with Publicis Selling Services(Publicis) pursuant to which approximately 33 part-time Publicis salesrepresentatives detail GLUMETZA to physicians. Publicis began detailing GLUMETZA to physicians in February 2008.The term of the agreement is six months, with options to extend or shorten thelength of the agreement.

 

*Promotion Fees*. In October 2007, we terminated ourpromotion agreement with King related to GLUMETZA. Pursuant to the terminationagreement, we are not required to pay King promotion fees on sales of GLUMETZAfor periods after September 30, 2007. We are in discussions with potential marketing partners for GLUMETZA inthe United States.

 

*1000mg Formulation*.  In December 2007,the FDA approved the 1000mg formulation for marketing in the UnitedStates.  We expect the 1000mg GLUMETZA tobe available late in the second quarter of 2008.

 

 

***ProQuin® XR***

 

*Watson Pharma.*In July 2007, we entered into a promotion agreement with WatsonPharma, a subsidiary of Watson Pharmaceuticals, granting Watson a co-exclusiveright to promote ProQuin XR to the urology specialty and long-term carefacilities in the United States.  In September 2007,we amended the agreement to also grant Watson a co-exclusive right to promoteProQuin XR to the ob/gyn specialty. Watson is required to deliver a minimum number of annual sales detailcalls and maintain a sales force of a minimum size.  Watson receives a promotion fee equal to anagreed upon portion of gross margin attributable to the urology and ob/gynspecialties and long-term care facilities above an agreed upon baseline level.We are responsible for the manufacture and distribution of ProQuin XR. Eachparty bears all of its own personnel and other costs, including marketingexpenses. The term of the promotion agreement is three years, subject to earlytermination in certain circumstances, with up to two additional one-yearrenewal periods at the election of Watson. We have retained the right topromote ProQuin XR to physicians outside the urology and ob/gyn specialties andlong-term care markets, either directly or through third parties. We and Watsonre-launched ProQuin XR in October 2007.

 

*Madaus/Rottapharm*.  In November 2005, we entered into adistribution and supply agreement for ProQuin XR in Europe with a privatelyowned specialty pharmaceutical company, Madaus S.r.l., who was acquired byRottapharm in June 2007. Under the terms of the agreement, we granted anexclusive right to Madaus for the commercialization of ProQuin XR in Europe andagreed to supply Madaus with commercial quantities of ProQuin XR tablets inbulk form.  In March 2006, Madausfiled a Marketing Authorization Application for ProQuin XR with the MedicalProducts Agency in Sweden.  We 

 

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assisted Madaus with a response to comments and questions on theMarketing Authorization Application that Madaus received in May 2007. Madaus submitted its response to the Swedish Medical Products Agency’squestions and comments in August 2007, and submitted responses to furtherquestions and comments in December 2007. We anticipate that the Medical Products Agency will make a finaldetermination on the application before the end of the second quarter of 2008.

 

***PRODUCT CANDIDATES***

 

## ***Gabapentin GR*****®**

 

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

 

The primary objective of the study is to assess theefficacy of Gabapentin GR in reducing the pain associated with PHN, measuredfrom baseline pain scores to the end of a ten-week treatment period on thebasis of the Likert pain scale.  Secondary objectives include anassessment of changes from baseline in sleep interference, and additionalpatient and clinician assessments of pain and quality of life.

 

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

 

*Menopausal Hot Flashes*.    In February 2008, weannounced positive results of our Phase 2 trial for Gabapentin GR for thetreatment of women with moderate-to-severe menopausal hot flashes.

 

*Phase 2 Study.*  In June 2007, we randomized the firstpatient in a Phase 2 double-blind, placebo-controlled, multi-center trialevaluating Gabapentin GR for the treatment of women with moderate-to-severemenopausal hot flashes.  The 124 patientstudy was fully enrolled in September 2007.

 

*Study Design.*The study included124 menopausal women (approximately 30 per group) with recurrent, moderate tosevere hot flashes and was conducted at eight sites in the United States.  The total study treatment duration after screeningand baseline was 13 weeks.  The primaryobjective of the study was to investigate the relationship between blood plasmaconcentrations of gabapentin observed in menopausal women after administrationof Gabapentin GR and the frequency of hot flashes in those women.  The plasma concentration data(pharmacokinetics) and the hot flash frequency and severity data(pharmacodynamics) are being used to construct a PK/PD dose response modeldesigned to identify the dosing regimen to utilize in the Phase 3 program.

 

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

 
| **Treatment Group**       | ** ** | **Weeks 2 – 6** | ** ** | **Weeks 8 – 12** |
|--------------------------------|------------|-------------------------------------|------------|--------------------------------------|
| A  (“1800mg group”)  |       | 600mg  PM                           |       | 600mg  AM+ 1200mg PM                 |
| B  (“2400mg group”)  |       | 600mg  AM+ 600mg PM                 |       | 600mg  AM+ 1800mg PM                 |
| C  (“3000mg group”)  |       | 1200mg  PM                          |       | 1200mg  AM+ 1800mg PM                |
| D  (“placebo group”) |       | placebo                             |       | placebo                              |

 

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

 

*Efficacy*.  Gabapentin GR demonstrated a reduction in themean frequency of moderate to severe hot flashes, and in the mean total daily severityof hot flashes, in all active treatment groups. Statistical significancerelative to placebo from baseline to the end of the study was observed in the1800mg and 2400mg treatment groups with regard to frequency, and statisticalsignificance was observed in the 1800mg treatment group with regard toseverity. The severity of hot flashes is based on a mean daily composite score,where a moderate hot flash is assigned a score of “2” and a severe hot flash isassigned a score of “3”.  The primaryefficacy outcomes observed in the study are set forth in the table below.

 
| **Treatment** | ** ** | **Mean Daily Frequency (#)** | ** ** | **Mean Total Daily Severity Score** |
|---------------|------------|------------------------------|------------|-------------------------------------|
| **Group**     | ** ** | **Baseline**                 | ** ** | **End of treatment**                | ** ** | **Baseline** | ** ** | **End of treatment** |
| 1800mg        |       | 10.1                         |       | 2.7 (p = 0.016)                     |   | 24.0 |   | 6.4 (p = 0.022) |
| 2400mg        |       | 11.8                         |       | 3.0 (p = 0.03)                      |   | 29.6 |   | 7.9 (p = 0.063) |
| 3000mg        |       | 11.4                         |       | 3.9 (p = 0.229)                     |   | 27.8 |   | 10.2 (p = 0.334) |
| placebo       |       | 10.6                         |       | 5.1                                 |   | 26.7 |   | 12.6 |

 

17

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*Safety. *GabapentinGR was generally well tolerated in the study, with one, two, one and threepatients, respectively, withdrawing due to adverse events from the placebo,1800mg, 2400mg and 3000mg groups.  Themost common side effects observed in the study were headache, somnolence,dizziness and nausea.  The incidence ofthose side effects in each of the treatment groups is set forth in the tablebelow.

 
| **Treatment Group** | ** ** | **Somnolence (%)** | ** ** | **Dizziness (%)** | ** ** | **Headache (%)** | ** ** | **Nausea (%)** | ** ** |
|--------------------------|------------|-------------------------|------------|------------------------|------------|-----------------------|------------|---------------------|------------|
| 1800mg                   |       | 16                      |       | 10                     |       | 32                    |       | 16                  |       |
| 2400mg                   |       | 16                      |       | 39                     |       | 32                    |       | 3                   |       |
| 3000mg                   |       | 16                      |       | 9                      |       | 25                    |       | 3                   |       |
| placebo                  |       | 3                       |       | 10                     |       | 10                    |       | 7                   |       |

 

***OTHER RESEARCH AND DEVELOPMENT AND COLLABORATIVEPROGRAMS***

 

*Supernus*.  In September 2006, we entered into acollaboration agreement with Supernus Pharmaceuticals, Inc. to developthrough a Phase 1 study a product candidate leveraging our AcuForm drugdelivery technology.  The cost andownership of the program will be shared between the parties equally. Thecollaboration agreement includes provisions pursuant to which the parties maynegotiate and enter into a definitive agreement for the further development andfor commercialization, by either or both parties, of the productcandidate.  We expect the feasibilityphase of the collaboration to be completed in the second quarter of 2008.

 

**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. Except as described below under “***Stock-BasedCompensation***”, there have been no changes to our criticalaccounting policies since we filed our 2007 Annual Report on Form 10-Kwith the Securities and Exchange Commission on March 12, 2008. For adescription of our critical accounting policies, please refer to our 2007 AnnualReport on Form 10-K.

 

***Stock-Based Compensation***

 

As of January 1, 2006, we began accounting forstock-based compensation in accordance with Statement of Financial AccountingStandards No. 123 (revised 2004), *Share-Based Payment*(FAS 123(R)), using the modified prospective transition method. We use theBlack-Scholes option valuation model to estimate the fair value of stockoptions and Employee Stock Purchase Plan (ESPP) shares. The Black-Scholes modelrequires the input of highly subjective assumptions. The most significantassumptions are our estimates of the expected volatility and the expected termof the award. For our volatility assumption, we use the historical volatilityof our common stock over the expected term of the options.

 

On adoption of FAS 123(R), we concluded that ourhistorical share option exercise experience did not provide a reasonable basisupon which to estimate expected term and estimated the expected term of optionsgranted by taking the average of the vesting term and the contractual term ofthe option, as illustrated by the simplified method in SEC Staff AccountingBulletin (SAB) No. 107 (SAB 107). SAB 107 allowed for use of the simplified method to estimate expectedterm through December 31, 2007, and we used the simplified method toestimate the expected term for fiscal years 2006 and 2007. In December 2007,the SEC issued SAB 110, which extended the ability for companies to utilize thesimplified method beyond December 31, 2007 under limitedcircumstances.  However, we elected to nolonger utilize the simplified method after December 31, 2007.  At January 1, 2008, we concluded againthat our historical share option exercise experience did not provide areasonable basis upon which to estimate expected term because of limited exercisehistory.  For options granted after January 1,2008, we have estimated the expected term by using the weighted average of apeer group of companies that grant options with similar vestingprovisions.  The expected term used foroptions granted after January 1, 2008 is 5.04 years.

 

As required, we review our valuation assumptions at each grant dateand, as a result, we are likely to change our valuation assumptions used tovalue employee stock-based awards granted in future periods. FAS 123(R) requiresthat employee and director stock-based compensation costs be recognized overthe vesting period of the award, and we have elected to use the straight-lineattribution method.

 

18

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FAS 123(R) requires forfeitures to be estimatedat the time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. We estimated forfeitures based onhistorical experience. Prior to the adoption of FAS 123(R), pro forma informationrequired under FAS 123 included forfeitures as they occurred.

 

### **RESULTS OF OPERATIONS**

### ** **

*Three Months EndedMarch 31, 2008 and 2007*

* *

### **Revenue**

### ** **

Totalrevenues are summarized in the following table (in thousands):

 
| ** **              | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Product sales:          |       |                                                 |       |   |   |
| GLUMETZA                |       | $                                                    | 5,166      |   | $ | 1,332 |   |
| ProQuin XR              |       | 60                                                   |       | — |   |
| Total product sales     |       | 5,226                                                |       | 1,332 |   |
|                    |       |                                                 |       |   |   |
| Royalties:              |       |                                                 |       |   |   |
| GLUMETZA                |       | 112                                                  |       | 34 |   |
| ProQuin XR              |       | —                                               |       | — |   |
| Total royalties         |       | 112                                                  |       | 34 |   |
|                    |       |                                                 |       |   |   |
| License revenue:        |       |                                                 |       |   |   |
| GLUMETZA                |       | 363                                                  |       | 1,269 |   |
| ProQuin XR              |       | —                                               |       | 694 |   |
| AcuForm technology |       | —                                               |       | 500 |   |
| Total license revenue   |       | 363                                                  |       | 2,463 |   |
|                    |       |                                                 |       |   |   |
| Total revenues          |       | $                                                    | 5,701      |   | $ | 3,829 |   |

 

***Product sales***

 

TheGLUMETZA product that we sell to wholesalers and retail pharmacies is subjectto rights of return of up to twelve months after product expiration. Given thelimited sales history of GLUMETZA and return privileges, we currently cannotreliably estimate expected returns of the product at the time of shipment.  We defer recognition of revenue on productshipments of GLUMETZA until the right of return no longer exists, which occursat the earlier of the time GLUMETZA units are dispensed through patientprescriptions or expiration of the right of return. We estimate the volume ofprescription units dispensed by pharmacies based on an analysis of third-partyinformation, including third-party market research data and informationobtained from certain wholesalers with respect to inventory levels. For thethree months ended March 31, 2008, we recognized approximately $5.2million of product sales of GLUMETZA, which is net of estimated patient supportprogram discounts, wholesaler fees, stocking allowances, prompt paymentdiscounts, chargebacks and Medicaid rebates. We have deferred recognition ofrevenue on GLUMETZA product shipments to customers which we estimate have notbeen dispensed through patient prescriptions. At March 31, 2008, we have adeferred revenue balance, which is classified as a liability on theconsolidated balance sheet, of $6.6 million associated with the deferral ofrevenue on GLUMETZA product shipments, which is net of estimated patientsupport program discounts, wholesaler fees, stocking allowances, prompt paymentdiscounts, chargebacks and Medicaid rebates.

 

Theincrease in GLUMETZA product revenue for the quarter ended March 31, 2008as compared to the quarter ended March 31, 2007 is the result of anadditional year of promotional and marketing efforts related to GLUMETZA, asGLUMETZA was launched in September 2006. In October 2007, weterminated our promotion agreement related to GLUMETZA with King and King’spromotion obligations ended in December 2007. In February 2008, webegan detailing 

 

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GLUMETZAthrough a contract sales organization, as we do not have an established salesorganization. We are unable to estimate whether we expect product sales forGLUMETZA to change from its current runrate as this may be dependent on thesuccess of our contract sales organization as well as the timing of, or theability to find one or more commercialization partners for GLUMETZA.

 

InOctober 2007, we re-launched ProQuin XR with Watson, and began selling towholesalers and retail pharmacies. 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 31,2008, we have a deferred revenue balance, which is classified as a liability onthe consolidated balance sheet, of $0.7 million associated with thedeferral of revenue on ProQuin XR product shipments, which is net of estimatedwholesaler fees, stocking allowances, prompt payment discounts, chargebacks andMedicaid rebates.  As ProQuin XR is inthe early stages of re-launch, we expect product sales of ProQuin XR toincrease in 2008.

 

***Royalties***

 

GLUMETZAroyalties relate to royalties we received from Biovail based on net sales ofGLUMETZA in Canada and royalties we received from LG based on net sales of LG’sversion of GLUMETZA, Novamet GR, in Korea. We began receiving royalties fromBiovail in the first quarter of 2006 and from LG in the first quarter of 2007.

 

***License revenue***

 

Licenserevenue for the quarter ended March 31, 2008 consisted solely of licenserevenue recognized from the $25.0 million upfront license fee received fromBiovail in July 2005. We are recognizing the $25.0 million license feepayment as revenue ratably until February 2023, which represents theestimated length of time our obligations exist under the arrangement related toroyalties we are obligated to pay Biovail on net sales of GLUMETZA in theUnited States and for our obligation to use Biovail as our sole supplier of the1000mg GLUMETZA.

 

Licenserevenue for the quarter ended March 31, 2007 consisted of revenuerecognized related to the Biovail agreement for GLUMETZA, and also includedrevenue recognized on agreements with Esprit Pharma for ProQuin XR, LG LifeSciences for GLUMETZA, and Biovail related to our AcuForm drug deliverytechnology.

 

Ourlicense agreement with Esprit for ProQuin XR provided for $50.0 million inlicense fees from Esprit. We received $30.0 million in license fees in July 2005and an additional $10.0 million in December 2006. The final $10.0 millioninstallment was paid in July 2007. The first $40.0 million in license feesreceived were recognized as revenue ratably commencing on our receipt of thefees through June 2020, which represented the length of time we wereobligated to manufacture ProQuin XR under our ProQuin XR supply agreement withEsprit. In July 2007, we and Esprit terminated the license and supplyagreements, and all deferred revenue related to license fees previouslyreceived from Esprit was fully recognized as revenue in July 2007.

 

Wereceived a $0.6 million upfront license fee from LG in August 2004 and a$0.5 million milestone payment received in November 2006 with respect toLG’s approval to market LG’s version of GLUMETZA, Novamet GR, in the Republicof Korea. These payments were originally deferred and amortized as licenserevenue over the estimated length of time we were obligated to provideassistance in development and manufacturing. In January 2007, we amendedour agreement with LG, granted LG a license to certain of the Company’sintellectual property rights to manufacture the 500mg Novamet GR in exchangefor royalties on net sales of Novamet GR in Korea, and removed the provisionsof the original agreement providing for the supply of 500mg Novamet GR tabletsby us to LG. Under the amended agreement, we no longer have continuingperformance obligations to LG, and recognized the remaining $0.9 million ofpreviously deferred license revenue in the first quarter of 2007.

 

InFebruary 2007, we received $0.5 million from Biovail upon entering into alicense and development agreement with Biovail granting Biovail an option tolicense our AcuForm drug delivery technology to develop and commercializeup to two pharmaceutical products. We have no continuing performanceobligations under the agreement. Accordingly, we recognized the entire upfrontlicense fee as revenue in the first quarter of 2007.

 

**Cost ofSales**

 

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. Total cost of sales for the three months ended March 31,2008, as compared to the prior year, was as follows (in thousands):

 
| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|------------------------------------------------------|------------|
| ** **    | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Cost of sales |       | $                                                    | 1,209      |   | $ | 306 |   |
|               |            |                                                      |            |  |  |  |  |

 

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Cost of sales for the three months ended March 31,2008 and 2007 relates primarily to costs associated with the sale of GLUMETZAand ProQuin XR. Cost of sales increased in 2008 over 2007 primarily as a resultof an increase in GLUMETZA product sales. During the three months ended March 31,2008, cost of sales also included approximately $0.3 million in inventorywrite-downs related to slow moving ProQuin XR inventory that we expect will notbe sold prior to its expiration date.

 

The costs of manufacturing associated with deferred revenueon GLUMETZA and ProQuin XR product shipments are recorded as deferred costs,which are included in inventory, until such time the related deferred revenueis recognized.

 

**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. Total research and development expense for thefirst quarter of 2008, as compared to the prior year, was as follows (inthousands):

 
| ** **                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Research and development expense  |       | $                                                    | 6,069      |   | $ | 8,572 |   |
| Dollar change from prior year     |       | (2,503                                               | )          |   |   |
| Percentage change from prior year |       | (29.2                                                | )%         |   |   |
|                                   |            |                                                      |            |  |  |  |  |

 

The decrease in research and development expense forthe three months ended March 31, 2008 as compared to the three monthsended March 31, 2007 was primarily due to lower headcount as a result ofimplementation of a reduction in force in September 2007 and also due tolower clinical research organization expenses related to our first Phase 3clinical trial for Gabapentin GR for the treatment of postherpetic neuralgia,which was completed in the first half of 2007. We commenced a second Phase 3clinical trial for Gabapentin GR for the treatment of postherpetic neuralgiaduring the first quarter of 2008 and expect research and development expense toincrease in subsequent quarters of 2008.

 

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

 
| ** **                              | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Gabapentin GR (PHN)                     |       | $                                                    | 3,966      |   | $ | 6,441 |   |
| Gabapentin GR (Hot Flashes)             |       | 1,416                                                |       | 667 |   |
| Other projects                          |       | 687                                                  |       | 1,464 |   |
| Total research and development expenses |       | $                                                    | 6,069      |   | $ | 8,572 |   |

 

**Selling, General and AdministrativeExpense**

 

Selling,general and administrative expenses primarily consist of personnel expenses tosupport our operating activities, marketing and promotion expenses associatedwith GLUMETZA and ProQuin XR, facility costs and professional expenses, such aslegal and accounting fees. Total selling, general and administrative expenses,as compared to the prior year, were as follows (in thousands):

 
| ** **                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Selling, general and administrative |       | $                                                    | 6,507      |   | $ | 6,227 |   |
| Dollar change from prior year       |       | 280                                                  |       |   |   |
| Percentage change from prior year   |       | 4.5                                                  | %          |   |   |
|                                     |            |                                                      |            |  |  |  |  |

 

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Theincrease in selling, general and administrative expense for the quarter ended March 31,2008 as compared to the quarter ended March 31, 2007, was primarily due tocosts associated with our professional detailing services agreement withPublicis, pursuant to which approximately 33 part-time Publicis sales representativesdetail GLUMETZA to physicians, and an increase in legal expenses related to ourlitigation with IVAX.  These increaseswere partially offset by a decrease in promotion fee expense, as we and Kingterminated our promotion agreement in October 2007, and we no longer haveobligations to pay King promotion fees related to GLUMETZA.

 

**Interest and Other Income**

 
| ** **                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| **(in thousands)**           | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Interest and other income         |       | $                                                    | 803        |   | $ | 410 |   |
| Dollar change from prior year     |       | 393                                                  |       |   |   |
| Percentage change from prior year |       | 95.9                                                 | %          |   |   |
|                                   |            |                                                      |            |  |  |  |  |

 

Interest and other income increased during the three months ended March 31,2008 as compared to the corresponding period in 2007 due to higher investmentbalances in the three months ended March 31, 2008 resulting from thereceipt of $29.7 million in termination fees from King and $17.5 million inlicense and termination fees from Esprit in the second half of 2007.

 

**LIQUIDITY AND CAPITAL RESOURCES**

** **
| **(in thousands)**                           | ** ** | **March 31,   2008** | ** ** | **December 31,   2007** | ** ** |
|---------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| Cash, cash equivalents and marketable  securities |       | $                              | 63,684     |                              | $          | 69,523 |   |
|                                                   |            |                                |            |                                   |            |  |  |

 

Sinceinception through March 31, 2008, we have financed our product developmentefforts and operations primarily from private and public sales of equitysecurities and receipts of upfront license and termination fees fromcollaborative and license partners.

 

InDecember 2006, we entered into a common stock purchase agreement withAzimuth Opportunity, Ltd., pursuant to which Azimuth is committed to purchase,from time to time and at our sole discretion, up to the lesser of (a) $30.0million of our common stock, or (b) 8,399,654 shares of common stock.Sales to Azimuth under the agreement, if any, will occur over a 24-month termand will be made at a price equal to the average closing price of our commonstock over a given pricing period, minus a discount ranging from approximately3.8% to 6.4%, which varies based on a threshold price set by us. Upon each saleof the our common stock to Azimuth under the agreement, we have also agreed topay Reedland Capital Partners a placement fee equal to approximately 1.1% ofthe aggregate dollar amount of common stock purchased by Azimuth. Azimuth isnot required to purchase our common stock when the price of our common stock isbelow $2 per share. As of March 31, 2008, we have not sold any commonstock to Azimuth under this common stock purchase agreement.

 

Asof March 31, 2008, we have accumulated net losses of $142.2 million. Weexpect to continue to incur operating losses in 2008. We anticipate that ourexisting capital resources will permit us to meet our capital and operationalrequirements through at least the end of 2009. We base this expectation on ourcurrent operating plan, which may change as a result of many factors.

** **

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

 

·          sales of our marketed products;

 

22

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·          expenditures related to our commercializationand development efforts;

·          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;

·          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.

 

The inability to raiseadditional capital would have a material adverse effect on our company.

** **

### **Cash Flows from OperatingActivities**

### ** **

Cash used in operating activities during the threemonths ended March 31, 2008 was approximately $5.9 million, compared tocash used in operating activities of approximately $8.0 million for the threemonths ended March 31, 2007. During the three months ended March 31,2008 and 2007, cash used in operating activities was primarily due to our netloss adjusted for stock-based compensation, depreciation expense and movementsin working capital.

 

The decrease in cash used in operating activities forthe three months ended March 31, 2008 as compared to three months ended March 31,2007 was primarily due to a decrease in net loss.

 

**Cash Flows from Investing Activities**

 

Net cash provided by investing activities during thethree months ended March 31, 2008 was approximately $3.1 million andconsisted of a $3.1 million net increase in marketable securities. Cash used ininvesting activities during the three months ended March 31, 2007 wasapproximately $1.6 million and consisted of a net increase in marketablesecurities.

 

**Cash Flows from Financing Activities**

 

Cash provided byfinancing activities during the three months ended March 31,2008 was approximately $3,000 compared to cashprovided by financing activities of approximately $0.2 million for the sameperiod in 2007. In the three months ended March 31, 2008 and 2007, the amounts consisted of cash proceeds fromexercises of stock options.

 

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**Contractual Obligations**

 

As of March 31, 2008, 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           |       | $                                     | 1,492      |               | $          | 445                |       | $         | 3          |   | $ | 1,940 |   |
| Related party arrangements |       | 358                                   |       | —             |       | —             |       | 358       |       |
| Purchase commitments       |       | 5,414                                 |       | —             |       | —             |       | 5,414     |       |
|                       |       | $                                     | 7,264      |               | $          | 445                |       | $         | 3          |   | $ | 7,712 |   |

 

At March 31, 2008,we had non-cancelable purchase orders and minimum purchase obligations ofapproximately $1.9 million under our manufacturing agreement with MOVAPharmaceuticals for the manufacture of the 500mg GLUMETZA and $0.9 millionunder our supply agreement with Biovail for the supply of the 1000mg GLUMETZA.We also had a non-cancelable purchase order to purchase in January 2009approximately $2.6 million of gabapentin, the active ingredient in GabapentinGR, from a third-party supplier. The amounts disclosed only represent minimumpurchase requirements. Actual purchases are expected to exceed these amounts.

 

We have a consultingarrangement with John W. Fara, Ph.D., our former Chairman, President and ChiefExecutive and current member of the Company’s Board of Directors and areobligated to pay Dr. Fara $187,000 for consulting services for the remainderof 2008. We also have a consulting arrangement with John F. Hamilton, ourformer Vice President, Finance and Chief Financial Officer and are obligated topay Mr. Hamilton $171,000 for consulting services through October 2008.

 

The contractualobligations reflected in this table exclude $3.5 million of contingentmilestone payments we may be obligated to pay in the future under oursublicense agreement with PharmaNova. These payments relate to variousmilestones for the product candidate under the sublicense agreement, includingdosing of the first patient in any Phase 3 trial, submission to the FDA of anNDA, and FDA approval of an NDA. The above table also excludes any futureroyalty payments we may be required to pay on products we have licensed or anypromotion fees associated with our promotion agreement with Watson.

 

**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 31,2007.

** **

**ITEM 4. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

An evaluation was performedunder the supervision and with the participation of our management, includingthe Company’s President and Chief Executive Officer along with its interimprincipal accounting and financial officer, of the effectiveness of the designand operation of our disclosure controls and procedures as of the end of theperiod covered by this quarterly report. Based on that evaluation, ourmanagement, including the Company’s President and Chief Executive Officer alongwith its interim principal accounting and financial officer, concluded that ourdisclosure 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 31,2008 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. IVAX***

 

Until April 2008,we were involved in legal proceedings relating to some of our intellectualproperty rights.  In January 2006, we filed a complaint against IVAXCorporation (IVAX) in the U.S. District Court for the Northern District ofCalifornia for infringement of U.S. Patent Nos. 6,340,475 and 6,635,280, bothof which we own.  The patents relate toour AcuForm delivery technology. The complaint alleges infringement of ourpatents by IVAX’s extended release metformin hydrochloride tablets.

 

In April 2008, weentered into a Settlement and License agreement with Teva Pharmaceuticals USA, Inc.,an affiliate of IVAX, that provided for a one-time payment to the Company of$7.5 million, and a non-exclusive license in favor of IVAX to continue tomarket its generic Glucophage® XR product in the United States under thepatents. The Company will also receive ongoing royalty payments from Teva onsales by Teva (including IVAX) of generic Glucophage XR in the United States.The royalty is subject to a $2.5 million aggregate cap.

 

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

 

In December 2007,Apotex, Inc. (Apotex) filed the Canadian equivalent of an Abbreviated NewDrug Application in Canada seeking approval to market a generic version of the500mg formulation of GLUMETZA in Canada. Apotex’s regulatory filing alleges that certain of the Canadian patentsthat we have licensed to Biovail in connection with Biovail’s commercializationof GLUMETZA in Canada are invalid and unenforceable, and that Apotex’sformulation does not infringe our patents. Pursuant to our Canadian license agreement with Biovail for GLUMETZA,Biovail has the first right to prosecute, and pay for expenses related to, anyCanadian litigation related to generic challenges to GLUMETZA.  In January 2008, Biovail filed suitagainst Apotex in Canada in response to Apotex’s regulatory filing, and we havebeen joined to the lawsuit as a co-plaintiff with Biovail because we are thelicensor of the patents at issue in the suit. The initiation of the lawsuit automatically stays approval of Apotex’sformulation for 24 months.  An adverseoutcome in this matter could substantially weaken 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, 2007.

 

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 ourconsolidated financial statements. These factors, among others, could causeactual results to differ materially from those currently anticipated andcontained in forward-looking statements made in this Form 10-Q andpresented elsewhere by our management from time to time. See “Part I, Item2—Forward-Looking Information.”

 

**Our prior Phase 3 trial for Gabapentin GR failedto meet the primary efficacy endpoint and there can be no assurance thisproduct will be approved.**

 

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

 

We submitted to the FDA aprotocol for a Phase 3 registration trial for Gabapentin GR to the FDA for aspecial protocol assessment, or SPA, pursuant to which we requested that theFDA assess whether the protocol is adequate to meet the scientific andregulatory requirements necessary to support marketing approval of GabapentinGR for PHN.  The FDA did provide us withguidance and comments on our proposed protocol, but indicated that the protocolwas not eligible for an SPA. Accordingly, there can be no assurance that the FDA will approveGabapentin GR for PHN for marketing even if we meet the primary endpoint in ourcurrent Phase 3 trial.

 

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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.  Even if these trials are successful, theapproval date for the drug will not for at least two years, which means that wewill not receive revenue from drug sales for a number of years, if at all.

 

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

 

In June 2006, we entered into a promotionagreement with King Pharmaceuticals pursuant to which King promoted GLUMETZA inthe United States through its sales force. In October 2007, following a strategic shift in focus by Kingtoward its neuroscience and hospital/acute care business, we and Kingterminated the promotion agreement. Pursuant to the termination of the promotion agreement, we receivedpayments from King of approximately $29.7 million.

 

We are seeking a new marketing partner forGLUMETZA.  However, we have not yetidentified a new marketing partner and we may not succeed in entering into amarketing arrangement for GLUMETZA on favorable terms, or at all.  We have not yet established a sales force,and we do not have immediate plans to do so. Accordingly, the success of GLUMETZA will depend in large part on ourability to identify and enter into a marketing arrangement with a newpartner.  Even if we enter into a new marketingarrangement for GLUMETZA, it may not be successful.  Any failure to successfully commercializeGLUMETZA could have a material adverse effect on our business, financialconditions, results of operations and cash flows.

 

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

 

Although we have engaged a contract sales organizationto promote GLUMETZA on a temporary basis, and we have the right to promoteProQuin XR through our own sales force, or through third parties, we have nosales force and limited marketing and sales staff.  The success of our own promotion efforts forGLUMETZA, ProQuin XR and any other product candidates that receive regulatoryapproval that we choose to market or co-market will require that wesubstantially enhance our in-house marketing and sales force with technicalexpertise, or make arrangements with third parties to perform theseservices for us.  The development of theinfrastructure associated with these activities involves substantial resources,and considerable attention of our management and key personnel. To the extentthat we enter into marketing and sales arrangements with other companies, ourrevenues will depend on the efforts of others. These efforts may not be successful.  If we fail to fully develop marketing andsales capabilities, or enter into arrangements with third parties, our revenuesmay suffer.

 

**We****depend on WatsonPharmaceuticals for the successful commercialization of ProQuin XR in theUnited States.**

 

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

 

**We are responsible for thedistribution of GLUMETZA and ProQuin XR, and we have limited experience withdistribution of pharmaceutical products.**

 

We are responsible for the distribution of GLUMETZAand ProQuin XR in the United States.  Ourin-house commercial operations and distribution capabilities are limited.  In addition, we have entered intodistribution arrangements with third parties, including Cardinal Health,AmeriSource Bergen and McKesson, and we will depend on them to ensure that ourmarketed products are widely available. To continue to support our commercialization effort related to ourmarketed products, we must continue to enhance our internal commercialinfrastructure, and continue to contract with capable third parties to assistus in our commercialization efforts.  Thecontinued development of that infrastructure will also require 

 

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substantial resources, which may divert the attention of ourmanagement and key personnel.  Theefforts of third parties with whom we contract for distribution of our productsmay not be successful.  Any failureon our part to successfully develop distribution capabilities could causedelays in product sales and incur increased costs.

 

**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 supply and distribution agreement with Madaus, a companyacquired by Rottapharm in June 2007, related to the commercialization ofProQuin XR in Europe. If our international commercial partners fail tosuccessfully commercialize products we have licensed to them, our business andfuture revenues may be adversely affected.

 

**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 thefollowing programs in clinical development:  Gabapentin GR for neuropathic pain, Gabapentin GR for menopausal hotflashes, omeprazole for gastroesophagealreflux disease, and a compound that is the subject of a feasibility studybetween us and Supernus Pharmaceuticals. We also have other product candidates in earlier 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 GabapentinGR for the treatment of postherpetic neuralgia that we completed in 2007.

 

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 the AcuForm technologycould have adverse effects or other characteristics that indicate it isunlikely to be effective as a delivery system for drugs or therapeutics, ourproduct development efforts and our business would be significantly harmed.

 

**Ourexisting resources may not be sufficient to fund our operations until such timeas we may be able to generate sufficient revenues to support our operations.**

 

Ourexisting capital resources may not be sufficient to fund our operations untilsuch time as we may be able to generate sufficient revenues to support ouroperations. We have limited credit facilities and, except for our common stockpurchase agreement with Azimuth, we have no other committed sources of capital.Our late stage clinical development programs will require considerablefinancial resources, and we may not be successful in entering into developmentand marketing arrangements in which a collaborative partner will pay for thecosts of those programs. To the extent that our capital resources areinsufficient to meet our future capital requirements, we will have to raiseadditional funds through the sale of our equity securities or from developmentand licensing arrangements to continue our development programs. We may beunable to raise such additional capital on favorable terms, or at all. If weraise additional capital by selling our equity or convertible debt securities,the issuance of such securities could result in dilution of our shareholders’equity positions. If adequate funds are not available we may have to:

 

·                  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.

 

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

 

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

 

To date, we have recorded limited revenues fromlicense fees, product sales, royalties, collaborative research and developmentarrangements and feasibility studies. For the quarter ended March 31,2008, we recorded total revenue of $5.7 million and for the years ended December 31,2007, 2006 and 2005, we recorded total revenue of $65.6 million, $9.6 million,and $4.4 million, respectively. For the quarter ended March 31, 2008, weincurred a net loss of $7.3 million and for the years 

 

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ended December 31, 2006 and 2005 we incurred net losses of $39.7million, and $24.5 million, respectively. The termination of our licenseagreement with Esprit in July 2007, including the accelerated recognitionof previously deferred revenue under the arrangement, and termination feesreceived associated with the termination of our promotion agreement with Kinghave resulted in our reaching profitability in 2007. However, as we continueour research and development efforts, preclinical testing and clinical trialactivities, we anticipate that we will incur operating losses in fiscal year2008. 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.

 

**Our operating resultsmay fluctuate and affect our stock price.**

 

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

 

·                  results of clinical trials for our productcandidates;

·                  announcements regarding development plans forour drug candidates, including Gabapentin GR;

·                  the degree of commercial success of GLUMETZA andProQuin XR;

·                  regulatory actions;

·                  adverse events related to our products,including recalls;

·                  interruptions of manufacturing or supply;

·                  results of litigation;

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

·                  variations in revenues obtained fromcollaborative agreements, including milestone payments, royalties, license feesand other contract revenues;

·                  decisions by collaborative partners toproceed or not to proceed with subsequent phases of a collaboration or program;

·                  market acceptance of the AcuForm technology;

·                  adoption of new technologies by us or ourcompetitors;

·                  the introduction of new products by ourcompetitors;

·                  manufacturing costs and difficulties;

·                  third-party reimbursement policies; and

·                  the status of our compliance with theprovisions of the Sarbanes-Oxley Act 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 Gabapentin GR Phase 3 trial results, could give rise to shareholderlawsuits, which are costly and time consuming to defend against and which mayadversely affect our ability to raise capital while the suits are pending, evenif 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 a have a collaboration agreementwith Supernus, Inc. providing for the development of a product candidatethrough feasibility, with the possibility to enter into a definitive agreementproviding for the further development of the product candidate, by either orboth parties.  We also have acollaboration arrangement with Patheon, Inc. related to the potentialdevelopment of product candidates for third parties.  In addition, we have in the past andmay in the future enter into other collaborative arrangements, some ofwhich have been based on less definitive agreements, such as memoranda ofunderstanding, material transfer agreements, options or feasibilityagreements.  We may not executedefinitive agreements formalizing these arrangements.  Collaborative relationships are generallycomplex and may give rise to disputes regarding the relative rights,obligations and revenues of the parties, including the ownership ofintellectual property and associated rights and obligations, especially whenthe applicable collaborative provisions have not been fully negotiated anddocumented. Such disputes can delay collaborative research, development orcommercialization of potential products, and can lead to lengthy, expensivelitigation or arbitration. The terms of collaborative arrangementsmay also limit or preclude us from developing products or technologiesdeveloped pursuant to such collaborations. Additionally, the collaboratorsunder these arrangements might breach the terms of their respective agreementsor fail to prevent infringement of the licensed 

 

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patents by third parties. Moreover, negotiating collaborativearrangements often takes considerably longer to conclude than the partiesinitially anticipate, which could cause us to enter into less favorableagreement terms that delay or defer recovery of our development costs andreduce the funding available to support key 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:

 

·                  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.

 

Generally, our collaborative arrangements do notrestrict 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.

 

**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 Gabapentin GR, or pharmacists could seek to fill prescriptions forGabapentin GR with another manufacturer’s gabapentin.  Although any such “off-label” use wouldviolate our licensed patent, effectively monitoring compliance with ourlicensed patent may be difficult and costly.

 

**It is difficult to develop a successful product. If wedo not develop a successful product we may not be able to raise additionalfunds.**

 

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 testsshowing that these products are safe and effective; and

·                  obtain regulatory approval from the FDA orforeign regulatory authorities.

 

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

 

·                  the AcuForm technology has unintended orundesirable side effects; or

·                  product candidates that appear promising inpreclinical or early-stage clinical studies do not demonstrate efficacy inlater-stage, larger scale clinical trials.

 

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

 

·                  market acceptance;

·                  cost-effective commercial scale production;and

·                  reimbursement under private or governmentalhealth plans.

 

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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 and wouldmake it difficult for us to raise financing on favorable terms, if at all.

 

**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 sometimesestimate the timing of the accomplishment of various scientific, clinical,regulatory and other product development and commercialization goals.  These milestones may include our expectationsregarding the commercial launchof our products by us or our licensees, and the commencement or completion ofscientific studies and clinical trials and the submission of regulatoryfilings.  From time to time, we maypublicly announce the expected timing of some of these milestones, such as thecompletion of an ongoing clinical trial, or the initiation of other clinicalprograms. All of these milestones are based on a variety of assumptions.  The actual timing of these milestones canvary considerably from our estimates depending on numerous factors, some ofwhich are beyond our control, including:

 

·                  our available capital resources;

·                  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; 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.

 

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**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, changes in regulatory policy for productapproval during the period of product development and regulatory agency reviewof each submitted new application may cause delays or rejections. Even if wereceive regulatory approval, this approval may entail limitations on theindicated uses for which we can market a product.

 

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 witha product or manufacturer may result in restrictions on the product,manufacturer or manufacturing facility, including withdrawal of the productfrom the market. Manufacturers of approved products are also subject to ongoingregulation, including compliance with FDA regulations governing current GoodManufacturing Practices (cGMP). Failure to comply with manufacturingregulations can result in, among other things, warning letters, fines,injunctions, civil penalties, recall or seizure of products, total or partialsuspension of production, refusal of the government to renew marketingapplications and criminal prosecution.

 

**Pharmaceutical marketingis subject to substantial regulation in the United States.**

 

All marketing activities associated with ProQuin XRand GLUMETZA, 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 criminalprosecution, civil penalties, seizure of products, injunction, and exclusion ofour products from reimbursement under government programs, as well as otherregulatory actions against our product candidates, our collaborative partnersor 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 foreign regulatoryapproval process includes all of the risks associated with obtaining FDAapproval set forth above, and approval by the FDA does not ensure approval bythe health authorities of any other country, nor does the approval by foreignhealth authorities ensure approval by the FDA.

 

**If we or our marketing partners areunable to obtain acceptable prices or adequate reimbursement for our productsfrom third-party payers, 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;

·                  health maintenance organizations;

·                  pharmacy benefit managementcompanies; and

·                  other healthcare-relatedorganizations.

 

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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 affectingpricing may 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 the AcuForm technologyinclude Bristol-Myers Squibb, IVAX Corporation (a subsidiary of TEVAPharmaceutical Industries, Ltd.), ALZA Corporation (a subsidiary of Johnson &Johnson), SkyePharma plc, Biovail Corporation, Flamel Technologies S.A.,Ranbaxy Laboratories, Ltd., Kos Pharmaceuticals, Inc., Intec Pharma andAlpharma, Inc., all of which develop oral tablet products designed torelease the incorporated drugs over time. Each of these companies has patentedtechnologies with attributes different from ours, and in some cases withdifferent sites of delivery 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 Barr Pharmaceuticals, Inc., Mylan Laboratories, Inc.and Teva Pharmaceutical Industries, Ltd. have received FDA approval for and areselling a controlled-release metformin product.

 

BayerCorporation developed a once-daily ciprofloxacin product for the treatment ofurinary tract infections, which is currently marketed by Schering-PloughCorporation. There are also generic versions of that product on the market. Theremay be other companies developing products competitive with GLUMETZA andProQuin 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 a new product, LyricaTM (pregabalin), which hasbeen approved for 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 drug deliverysystems and technologies.

 

**We depend on third parties who are single sourcesuppliers to manufacture GLUMETZA, ProQuin XR and our other productcandidates.  If these suppliers areunable to manufacture GLUMETZA, ProQuin XR or our product candidates, ourbusiness will be harmed.**

 

We are responsible for the supply and distribution ofGLUMETZA, and MOVA Pharmaceuticals, a subsidiary of Patheon, Inc., is oursole supplier for tablets of the 500mg strength of GLUMETZA pursuant to asupply agreement we entered into with MOVA Pharmaceuticals in December 2006.  Biovail is our sole supplier for the 1000mgformulation GLUMETZA.  We will be unableto manufacture GLUMETZA in a timely manner if we are unable to obtain GLUMETZA500mg tablets from our contract manufacturer, active pharmaceutical ingredientfrom suppliers, or excipient suppliers, or GLUMETZA 1000mg tablets fromBiovail.

 

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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 MOVAPharmaceuticals, as our sole supplier. We purchase the active ingredient forProQuin XR from Uquifa Mexico, S.A., a sole supplier to us, on a purchase orderbasis. We will also be responsible for the manufacture of bulk ProQuin XRtablets to Madaus for the European market, if the product is approved formarketing in European jurisdictions.  Weintend to purchase ProQuin XR tablets from MOVA Pharmaceuticals for thatpurpose. If we are unable, for whatever reason, to obtain the activepharmaceutical ingredient or ProQuin XR tablets from our contractmanufacturers, we may be unable to manufacture ProQuin XR in a timely manner,if at all.

 

Although we have obtained clinical batches ofGabapentin GR from a contract manufacturer, we currently have no long-termsupply arrangement with respect to Gabapentin GR.  Any failure to obtain clinical supplies ofGabapentin GR could adversely affect our Gabapentin GR clinical developmentprograms.

 

**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 Phase 3 clinical trials and commercialization. Our dependenceon third parties for the manufacture of products using the AcuForm technologymay adversely 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 2008 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. Our former Chairman, President and Chief Executive Officer retired in August 2007,and our Chief Financial Officer retired in October 2007. We may havedifficulty filling open senior scientific, financial and commercial positions.Management, scientific and operating personnel are in high demand in ourindustry and are often subject to competing offers. The loss of the services ofone or more members of management or key employees or the inability to hireadditional personnel as needed could result in delays in the research,development and commercialization of our products and potential productcandidates.

 

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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 ofdirectors to authorize the issuance of preferred stock with rights superior tothose of the common stock. We are also subject to the provisions of Section 1203of the California General Corporation Law which requires a fairness opinion tobe provided 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, regulationsand standards relating to corporate governance, public disclosure andcompliance practices, including the Sarbanes-Oxley Act of 2002, new SECregulations and NASDAQ Global Market rules, are creating uncertainty forcompanies such as ours in understanding and complying with these laws,regulations and standards.  As a resultof this uncertainty and other factors, devoting the necessary resources tocomply with evolving corporate governance and public disclosure standards has resulted in andmay in the future result in increased general and administrative expenses and adiversion of management time and attention to compliance activities.  We also expect these developments to increase our legal compliance andfinancial reporting costs.  In addition,these developments may make it more difficult and more expensive for us toobtain director and officer liability insurance, and we may be required toaccept reduced coverage or incur substantially higher costs to obtaincoverage.  Moreover, we may be unable tocomply with these new rules and regulations 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 ofcommon stock at a discount from the current trading price of our commonstock.  As a result, our existing commonshareholders will experience immediate dilution upon the purchase of any sharesof our common stock sold at such discount. For example, in December 2006, we entered into a common stockpurchase agreement with Azimuth Opportunity Ltd., pursuant to which we may sellshares of common stock at a discount to the prevailing market price rangingfrom approximately 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 ourinternal controls in the future, if we fail to complete future evaluations ontime, or if our external auditors cannot attest to our future evaluations, wecould fail to meet our regulatory reporting requirements and be subject toregulatory scrutiny and a loss of public confidence in our internal controls,which could have 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,telecommunications failures, intentional acts of vandalism and similar events.In particular, our corporate headquarters are located in the San Francisco Bay area, which has a history ofseismic activity. We have not established a formal disaster recovery plan, andour back-up operations and our business interruption insurance may not beadequate 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 EQUITYSECURITIES AND USE OF PROCEEDS**

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM 4.****                 ****SUBMISSION OF MATTERS TO A VOTEOF SECURITY HOLDERS**

 

Not applicable.

 

**ITEM 5.                  OTHER INFORMATION**

 

In April 2008, we issued 160,476 shares of our commonstock to a warrant holder in connection with a cashless exercise featurerelated to the exercise of warrants to purchase 419,154 shares of our commonstock. The warrants were issued to accredited investors in April 2003 in apreviously disclosed private placement transaction exempt from registrationunder the provisions of Rule 506 of Regulation D promulgated under theSecurities Act of 1933, as amended. The resale of the shares issued upon theexercise of the warrants has been registered on an effective Form S-3registration statement we filed with the SEC on May 2, 2003.

 

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**ITEM 6.EXHIBITS**

 
|   | (a)    | Exhibits |                                                                                                               |
|--------|--------|----------|--------------------------------------------------------------------------------------------------------------------|
|   |   | 10.1     | Offer Letter,  dated November 19, 2007, between the Company and Michael Sweeney, M.D.                         |
|   |   | 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 7,  2008 | DEPOMED, INC.             |
|-------------------------|--------------------------------|
|                    |                           |
|                    |                           |
|                    | /s/ Carl A.  Pelzel            |   |
|                    | Carl A. Pelzel                 |   |
|                    | President and                  |
|                    | Chief Executive  Officer       |
|                    |                           |
|                    |                           |
|                    | /s/ Tammy L.  Cameron          |   |
|                    | Tammy L. Cameron               |   |
|                    | Corporate  Controller          |
|                    | (Interim  Principal Accounting |
|                    | and Financial  Officer)        |

 

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