** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

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** **

**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, 2007**                          |
|                                                                        |       |                                                                                                    |   |   |
| **OR**                                                                      |
|                                                                        |       |                                                                                                    |   |   |
| **o**                                                                       | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                        |       |                                                                                                    |   |   |
| **FOR THE  TRANSITION PERIOD FROM        TO** |

 

**COMMISSION FILE NUMBER 000-23267**

** **

**DEPOMED, INC.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

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

 

**1360 O’BRIEN DRIVE**

**MENLO PARK, CALIFORNIA 94025**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

 

**(650) 462-5900**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Exchange Act during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

| Yes  x |   | No  o |
|------------------|--------|-----------------|

 

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

 

| Large accelerated filer  o |   | Accelerated  filer  x |   | Non-accelerated filer  o |
|--------------------------------------|--------|---------------------------------|--------|------------------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

 

| Yes  o |   | No  x |
|------------------|--------|-----------------|

 

The number of issued andoutstanding shares of the Registrant’s Common Stock, no par value, as of May 3,2007 was 47,470,067.

 

 

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** **

**DEPOMED, INC.**

 
|                                                                                                             | ** ** | **PAGE** |
|-------------------------------------------------------------------------------------------------------------|------------|----------|
| ** **                                                                                                  |       |     |
| **PART I —  FINANCIAL INFORMATION**                                                               |       |     |
|                                                                                                        |       |     |
| Item 1.  Condensed Consolidated Financial Statements (Unaudited):                                           |       |     |
|                                                                                                        |       |     |
| Condensed  Consolidated Balance Sheets at March 31, 2007 and December 31, 2006                         |       | 3        |
|                                                                                                        |       |     |
| Condensed  Consolidated Statements of Operations for the three-month periods ended March  31, 2007 and 2006 |       | 4        |
|                                                                                                        |       |     |
| Condensed  Consolidated Statements of Cash Flows for the three-month periods ended March  31, 2007 and 2006 |       | 5        |
|                                                                                                        |       |     |
| Notes to  Condensed Consolidated Financial Statements                                                       |       | 6        |
|                                                                                                        |       |     |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations        |       | 12       |
|                                                                                                        |       |     |
| Item 3.  Quantitative and Qualitative Disclosure About Market Risk                                          |       | 20       |
|                                                                                                        |       |     |
| Item 4. Controls and  Procedures                                                                            |       | 21       |
|                                                                                                        |       |     |
| **PART II — OTHER  INFORMATION**                                                                  |       |     |
|                                                                                                        |       |     |
| Item 1. Legal Proceedings                                                                                   |       | 22       |
|                                                                                                        |       |     |
| Item  1A. Risk Factors                                                                                      |       | 22       |
|                                                                                                        |       |     |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                        |       | 34       |
|                                                                                                        |       |     |
| Item 3.  Defaults upon Senior Securities                                                                    |       | 34       |
|                                                                                                        |       |     |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                |       | 34       |
|                                                                                                        |       |     |
| Item 5. Other Information                                                                                   |       | 34       |
|                                                                                                        |       |     |
| Item  6. Exhibits                                                                                           |       | 35       |
|                                                                                                        |       |     |
| Signatures                                                                                                  |       | 36       |

 

 

2

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** **

**PART I— FINANCIAL INFORMATION**

###### ITEM 1. CONDENSED CONSOLIDATED FINANCIALSTATEMENTS

 

**DEPOMED, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                    | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                    | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                                                                                                               |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                    |       | $                  | 5,164,531  |                  | $          | 14,574,110 |   |
| Marketable  securities                                                                                                                                                                                                                                                                        |       | 20,605,784         |       | 16,984,503            |       |
| Accounts  receivable                                                                                                                                                                                                                                                                          |       | 945,180            |       | 7,126,895             |       |
| Unbilled  accounts receivable                                                                                                                                                                                                                                                                 |       | 136,901            |       | 1,954,904             |       |
| Inventories                                                                                                                                                                                                                                                                                   |       | 4,390,834          |       | 4,483,157             |       |
| Prepaid and  other current assets                                                                                                                                                                                                                                                             |       | 3,261,273          |       | 2,756,174             |       |
| Total current  assets                                                                                                                                                                                                                                                                         |       | 34,504,503         |       | 47,879,743            |       |
| Marketable securities                                                                                                                                                                                                                                                                         |       | —             |       | 1,998,760             |       |
| Property and equipment,  net                                                                                                                                                                                                                                                                  |       | 2,281,894          |       | 2,541,463             |       |
| Other assets                                                                                                                                                                                                                                                                                  |       | 197,218            |       | 197,218               |       |
|                                                                                                                                                                                                                                                                                          |       | $                  | 36,983,615 |                  | $          | 52,617,184 |   |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                                                                                                                                                                                               | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                                                                                                                          |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                                                              |       | $                  | 4,567,652  |                  | $          | 4,886,222 |   |
| Accrued  compensation                                                                                                                                                                                                                                                                         |       | 1,215,588          |       | 1,817,418             |       |
| Accrued clinical  trial expense                                                                                                                                                                                                                                                               |       | 918,103            |       | 726,379               |       |
| Accrued  promotion fee expense                                                                                                                                                                                                                                                                |       | 246,461            |       | 2,339,925             |       |
| Other accrued  liabilities                                                                                                                                                                                                                                                                    |       | 3,246,232          |       | 3,087,998             |       |
| Deferred product  sales                                                                                                                                                                                                                                                                       |       | 4,024,209          |       | 4,825,099             |       |
| Deferred license  revenue                                                                                                                                                                                                                                                                     |       | 4,437,848          |       | 4,599,947             |       |
| Other current  liabilities                                                                                                                                                                                                                                                                    |       | 55,845             |       | 55,845                |       |
| Total current  liabilities                                                                                                                                                                                                                                                                    |       | 18,711,938         |       | 22,338,833            |       |
| Deferred license  revenue, non-current portion                                                                                                                                                                                                                                                |       | 55,682,302         |       | 57,483,045            |       |
| Other long-term  liabilities                                                                                                                                                                                                                                                                  |       | 69,805             |       | 83,766                |       |
| Commitments                                                                                                                                                                                                                                                                                   |       |               |       |                  |       |
| Shareholders’ deficit:                                                                                                                                                                                                                                                                   |       |               |       |                  |       |
| Preferred stock,  no par value, 5,000,000 shares authorized; Series A convertible  preferred stock, 25,000 shares designated, 18,158 shares issued and  outstanding at March 31, 2007 and December 31, 2006, respectively, with  an aggregate liquidation preference of $18,158,848 |       | 12,015,000         |       | 12,015,000            |       |
| Common stock, no  par value, 100,000,000 shares authorized; 42,091,255 and 42,029,411 shares  issued and outstanding at March 31, 2007 and December 31, 2006,  respectively                                                                                                              |       | 145,482,641        |       | 144,820,534           |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                          |       | (194,977,497       | )          | (184,111,185          | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                                                         |       | (574               | )          | (12,809               | )          |
| Total  shareholders’ deficit                                                                                                                                                                                                                                                             |       | (37,480,430        | )          | (27,288,460           | )          |
|                                                                                                                                                                                                                                                                                          |       | $                  | 36,983,615 |                  | $          | 52,617,184 |   |

 

See accompanying notes to Condensed Consolidated Financial Statements.

 

3

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** **

**DEPOMED, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                           | ** ** | **Three Months Ended March 31,** | ** **  |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|
| ** **                                                                           | ** ** | **2007**                                             | ** **  | **2006** | ** ** |
| Revenue:                                                                             |       |                                                 |        |   |   |
| Product sales                                                                        |       | $                                                    | 1,331,766   |   | $ | 99,673 |   |
| Royalties                                                                            |       | 34,225                                               |        | 349,321 |   |
| License revenue                                                                      |       | 2,462,842                                            |        | 893,165 |   |
| Total  revenues                                                                      |       | 3,828,833                                            |        | 1,342,159 |   |
|                                                                                 |       |                                                 |        |   |   |
| Costs and expenses:                                                                  |       |                                                 |        |   |   |
| Cost of sales                                                                        |       | 305,660                                              |        | 74,353 |   |
| Research and  development                                                            |       | 8,572,341                                            |        | 5,684,082 |   |
| Selling, general  and administrative                                                 |       | 6,226,646                                            |        | 3,931,293 |   |
| Total costs and  expenses                                                            |       | 15,104,647                                           |        | 9,689,728 |   |
|                                                                                 |       |                                                 |        |   |   |
| Loss from operations                                                                 |       | (11,275,814                                          | )           | (8,347,569 | ) |
|                                                                                 |       |                                                 |        |   |   |
| Interest and other  income                                                           |       | 410,228                                              |        | 594,859 |   |
|                                                                                 |       |                                                 |        |   |   |
| Net loss before income  taxes                                                        |       | (10,865,586                                          | )           | (7,752,710 | ) |
|                                                                                 |       |                                                 |        |   |   |
| Provision for income  taxes                                                          |       | (726                                                 | )           | — |   |
|                                                                                 |       |                                                 |        |   |   |
| Net loss                                                                             |       | (10,866,312                                          | )           | (7,752,710 | ) |
|                                                                                 |       |                                                 |        |   |   |
| Deemed dividend on  preferred stock                                                  |       | (167,016                                             | )           | (172,632 | ) |
|                                                                                 |       |                                                 |        |   |   |
| Net loss applicable to  common stock shareholders                                    |       | $                                                    | (11,033,328 | ) | $ | (7,925,342 | ) |
|                                                                                 |       |                                                 |        |   |   |
| Basic and diluted net  loss applicable to common stock shareholders per common share |       | $                                                    | (0.26       | ) | $ | (0.19 | ) |
|                                                                                 |       |                                                 |        |   |   |
| Shares used in computing basic and diluted net loss per common share                 |       | 42,076,197                                           |        | 40,843,512 |   |

** **

See accompanying notes to Condensed Consolidated Financial Statements.

 

4

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** **

**DEPOMED, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** **  |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|
| ** **                                                                   | ** ** | **2007**                                             | ** **  | **2006** | ** ** |
| **Operating Activities**                                                     | ** ** | ** **                                           | ** **  | ** ** | ** ** |
| Net loss                                                                     |       | $                                                    | (10,866,312 | ) | $ | (7,752,710 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                                 |        |   |   |
| Depreciation and  amortization                                               |       | 226,149                                              |        | 377,103 |   |
| Employee and  director stock-based compensation                              |       | 489,251                                              |        | 548,313 |   |
| Stock-based  compensation related to consultants                             |       | 4,034                                                |        | — |   |
| Changes in  assets and liabilities:                                          |       |                                                 |        |   |   |
| Accounts  receivable                                                         |       | 7,999,718                                            |        | 226,197 |   |
| Inventories                                                                  |       | 92,323                                               |        | (481,934 | ) |
| Prepaid and  other current assets                                            |       | (505,099                                             | )           | (109,287 | ) |
| Accounts payable  and other accrued liabilities                              |       | (2,062,076                                           | )           | 1,649,768 |   |
| Accrued  compensation                                                        |       | (601,830                                             | )           | (976,857 | ) |
| Royalty advances                                                             |       | —                                               |        | 697,198 |   |
| Deferred revenue                                                             |       | (2,763,732                                           | )           | (20,156 | ) |
| Net cash (used  in) operating activities                                     |       | (7,987,574                                           | )           | (5,842,365 | ) |
|                                                                         |       |                                                 |        |   |   |
| **Investing Activities**                                                     | ** ** | ** **                                           | ** **  | ** ** | ** ** |
| Purchases of property  and equipment                                         |       | (34,030                                              | )           | (228,453 | ) |
| Purchases of marketable  securities                                          |       | (10,551,281                                          | )           | (8,524,040 | ) |
| Maturities of  marketable securities                                         |       | 8,994,484                                            |        | 12,046,674 |   |
| Sales of marketable  securities                                              |       | —                                               |        | 1,497,210 |   |
| Net cash (used  in) provided by investing activities                         |       | (1,590,827                                           | )           | 4,791,391 |   |
|                                                                         |       |                                                 |        |   |   |
| **Financing Activities**                                                     | ** ** | ** **                                           | ** **  | ** ** | ** ** |
| Proceeds from issuance  of common stock                                      |       | 168,822                                              |        | 1,680,286 |   |
| Net cash  provided by financing activities                                   |       | 168,822                                              |        | 1,680,286 |   |
|                                                                         |       |                                                 |        |   |   |
| Net (decrease) increase  in cash and cash equivalents                        |       | (9,409,579                                           | )           | 629,312 |   |
| Cash and cash  equivalents at beginning of period                            |       | 14,574,110                                           |        | 7,565,556 |   |
| Cash and cash equivalents at end of period                                   |       | $                                                    | 5,164,531   |   | $ | 8,194,868 |   |

 

See accompanying notes to Condensed Consolidated Financial Statements.

 

5

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** **

**DEPOMED, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

## ***Basis of Presentation***

These unaudited condensedconsolidated financial statements and the related footnote information of Depomed, Inc.(the Company 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, 2007 are not necessarily indicative of results to be expected for theentire year ending December 31, 2007 or future operating periods.

The balance sheet as ofDecember 31, 2006 has been derived from the audited financial statementsat that date. The balance sheet does not include all of the information and footnotesrequired by U.S. generally accepted accounting principles for completefinancial statements. For further information, refer to the financialstatements and footnotes thereto included in the Company’s annual report onForm 10-K for the year ended December 31, 2006 filed with the SEC.

***Principles of Consolidation***

The consolidatedfinancial statements for the three months ended March 31, 2007 and 2006 includethe accounts of the Company and Depomed Development, Ltd., DDL. DDL does nothave any fixed assets, liabilities or employees and will not perform anyfurther product development on behalf of Depomed or any other entity. Materialintercompany accounts and transactions have been eliminated. DDL was dissolvedin April 2007.

***Use of Estimates***

The preparation of financial statements in conformitywith U.S. generally accepted accounting principles requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from thoseestimates.

***Stock-Based Compensation***

Effective January 1,2006, Depomed implemented the provisions of Statement of Financial AccountingStandards No. 123 (revised 2004), *Share-Based Payment*(FAS 123(R)), as interpreted by SEC Staff Accounting Bulletin No. 107 (SAB107), using the modified prospective transition method. FAS 123(R) is a revisionof Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation*(FAS 123), andsupercedes APB Opinion No. 25, *Accounting for StockIssued to Employees* (APB No. 25).**FAS123(R) requires companies to recognize the cost of employee and directorservices received in exchange for awards of equity instruments, based on thegrant-date fair value of those awards, in the statement of operations. Usingthe modified prospective transition method of FAS 123(R), Depomed began recognizingfair-value compensation expense for stock-based awards, including stock optionsgranted and purchase rights issued under its employee purchase plan afterJanuary 1, 2006. Compensation expense for stock-based awards granted priorto implementation that were unvested and outstanding as of January 1, 2006is recognized over the requisite service period based on the grant-date fairvalue of 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. Under the modifiedprospective transition method of implementation, no restatement of priorperiods has been made. See Note 4 of the Notes to Condensed ConsolidatedFinancial Statements for further information regarding Depomed’s stock-basedcompensation expense.

6

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** **

***RevenueRecognition***

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 recognizedwhen there is persuasive evidence that an arrangement exists, delivery hasoccurred and title has passed, the price is fixed or determinable and theCompany is reasonably assured of collecting the resulting receivable.

The Company sellsGLUMETZA product to wholesalers and retail pharmacies that is subject to rightsof return up to twelve months after product expiration.  Given the limited sales history of GLUMETZA,the Company currently cannot reliably estimate expected returns of the productat the time of shipment. Accordingly, the Company defers recognition of revenueon product shipments of GLUMETZA until the right of return no longer exists,which occurs at the earlier of the time GLUMETZA units are dispensed throughpatient prescriptions or expiration of the right of return. The Companyestimates patient prescriptions dispensed using an analysis of third-partyinformation, including third-party market research data, information obtainedfrom certain wholesalers with respect to inventory levels and out-movement andretail pharmacy re-stocking activity. As a result of this policy, the Companyhas a deferred revenue balance of $4.0 million at March 31, 2007 related toGLUMETZA product shipments that have not been recognized as revenue, which isnet of estimated patient support program discounts, wholesaler fees, stockingallowances, prompt payment discounts and chargebacks. The Company willrecognize revenue upon the earlier of prescription units dispensed orexpiration of the right of return until it can reliably estimate productreturns, at which time the Company will record a one-time increase in netrevenue related to the recognition of revenue previously deferred. In addition,the costs of manufacturing GLUMETZA associated with the deferred revenue arerecorded as deferred costs, which are included in inventory, until such timethe deferred revenue is recognized.

Product sales revenue related to the Company’s supplyagreement with Esprit is recognized after the expiration of a 30-day period inwhich Esprit may reject product that does not meet agreed-upon specifications.

Royalties are recognized as earned in accordance withthe contract terms when royalties from licensees can be reliably measured andcollectibility is reasonably assured. The Company recognizes royalties underits agreement with Esprit based on Esprit’s sales of ProQuin XR, net of anyestimated returns, discounts, rebates and chargebacks. Esprit is obligated topay the Company annual minimum royalties. Total royalty revenue recognized bythe Company to date has been equal to Esprit’s minimum royalty obligation underthe agreement. Royalties received under the Company’s agreements with Biovailand LG are recognized when the royalty payments are received as they are notestimable. Royalty payments received in excess of amounts earned are classifiedas royalty advances until earned.

Revenue from licensearrangements, including license fees creditable against future royaltyobligations (if any), of the licensee, is recognized when an arrangement isentered into if the Company has substantially completed its obligations underthe terms of the arrangement and the Company’s remaining involvement isinconsequential and perfunctory. If the Company has significant continuinginvolvement under such an arrangement, license fees are deferred and recognizedover the estimated performance period. License fee payments received in excessof amounts earned are classified as deferred revenue until earned.

Collaborative revenuerecognized relates to services rendered in connection with collaborativearrangements and the achievements of milestones under such arrangements.Revenue related to collaborative agreements with corporate partners isrecognized 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.

7

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** **

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

The Company considers all highly liquid investmentswith an original maturity (at date of purchase) of three months or less to becash equivalents. Cash and cash equivalents consist of cash on deposit withbanks, money market instruments and commercial paper. The Company places itscash, cash equivalents and marketable securities with high quality, U.S. financialinstitutions and, to date, has not experienced material losses on any of itsbalances. The Company records cash and cash equivalents at amortized cost,which approximates the fair value. All marketable securities are classified asavailable-for-sale since these instruments are readily marketable. Thesesecurities are carried at fair value, which is based on readily availablemarket information, with unrealized gains and losses included in accumulatedother comprehensive income (loss) within shareholders’ equity. The Company usesthe specific identification method to determine the amount of realized gains orlosses on sales of marketable securities. Realized gains or losses have beeninsignificant and are included in “interest and other income” in the condensedconsolidated statement of operations. At March 31, 2007, the individualcontractual period for all available-for-sale debt securities is less than twoyears.

The following table shows the grossunrealized losses and fair value of the Company’s investments with unrealizedlosses that are not deemed to be other-than-temporarily impaired, aggregated byinvestment category and length of time that individual securities have been ina continuous unrealized loss position, at March 31, 2007:

 
| ** **                         | ** ** | **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  debt securities   |       | $                                      | 2,794,764  |                                    | $          | (513                | )          | $ | 3,994,760 |   | $ | (3,828 | ) | $ | 6,789,524 |   | $ | (4,341 | ) |
| U.S. corporate  debt securities    |       | 5,853,893                              |       | (1,757                                  | )          | —              |       | — |   | 5,853,893 |   | (1,757 | ) |
| Total  available-for-sale          |       | $                                      | 8,648,657  |                                    | $          | (2,270              | )          | $ | 3,994,760 |   | $ | (3,828 | ) | $ | 12,643,417 |   | $ | (6,098 | ) |

 

Thegross unrealized losses above were caused by interest rate increases. Nosignificant facts or circumstances have arisen to indicate that there has beenany deterioration 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 other-than-temporary impairments for these securities at March 31, 2007.

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

Netloss per common share is computed using the weighted-average number of sharesof common stock outstanding. Common stock equivalent shares, which are based onthe number of shares underlying outstanding stock options, warrants and otherconvertible securities, are not included as their effect is antidilutive. AtMarch 31, 2007 and 2006, the total number of outstanding common stockequivalent shares excluded from the loss per share computation was 8,550,392and 9,098,968, respectively.

8

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**NOTE4.  STOCK-BASED COMPENSATION**

The Company adopted FAS123(R) on January 1, 2006 as described in Note 1 of the Notes to CondensedConsolidated Financial Statements. Stock-based compensation expense recognizedunder FAS 123(R) in the condensed consolidated statements of operations relatedto stock options and the Company’s employee stock purchase program (ESPP) wasapproximately $493,000 and $548,000 for the three months ended March 31, 2007and 2006, respectively.  Stock-basedcompensation expense for the three months ended March 31, 2007 consisted of$201,000 in research and development expense, $288,000 in selling, general andadministrative expense and $4,000 in cost of sales. Stock-based compensationexpense for the three months ended March 31, 2006 consisted of $238,000 inresearch and development expense and $310,000 in selling, general andadministrative expense. At March 31, 2007, Depomed had $5.2 million of totalunrecognized compensation expense, net of estimated forfeitures, related tostock option grants that will be recognized over an average vesting period of2.5 years.

**NOTE5.  COMPREHENSIVE LOSS**

Totalcomprehensive loss for the three months ended March 31, 2007 and 2006approximates net loss and includes unrealized losses on marketable securities.

**NOTE6.  COLLABORATIVE ARRANGEMENTS ANDCONTRACTS**

***LG Life Sciences***

InJanuary 2007, the Company and LG Life Sciences further amended the parties’license and distribution agreement, originally entered into in August 2004 andsubsequently amended in November 2006. The amendment grants LG a license tomanufacture the 500mg GLUMETZA in exchange for royalties on net sales ofGLUMETZA in Korea and removes the provisions of the original agreementproviding for the supply of 500mg GLUMETZA tablets by the Company to LG. TheCompany received a $600,000 upfront license fee in August 2004 and a $500,000milestone payment in November 2006 with respect to LG’s approval to marketGLUMETZA in the Republic of Korea, both of which were originally deferred andamortized as revenue over the estimated length of time the Company wasobligated to provide assistance to LG in development and manufacturing. Underthe amended agreement, the Company no longer has continuing performanceobligations to LG that are other than inconsequential or perfunctory andaccordingly, the remaining $905,000 of previously deferred revenue wasrecognized as license revenue in the quarter ended March 31, 2007.

***Biovail***

In February 2007, the Company entered into a licenseand development agreement with Biovail granting Biovail an option to licensethe AcuForm drug delivery technology to develop and commercialize up to twopharmaceutical products. Pursuant to the agreement, Biovail paid the Company anupfront fee of $500,000 in February 2007, and is contingently obligated to paythe Company additional fees related to the exercise of the license option, theinitiation of the first Phase 3 trial for each product and upon receipt of U.S.regulatory approval for each product. The agreement also requires that Biovailmake royalty payments to the Company on net commercial sales of any productdeveloped under the agreement. As the Company has no continuing obligations toBiovail under the agreement that are other than inconsequential or perfunctory,the $500,000 upfront license fee was recognized as license revenue in thequarter ended March 31, 2007.

Also in February 2007, the Company amended its stockpurchase agreement with Biovail originally entered into in May 2002. Theamended stock purchase agreement removed Biovail’s observer rights on theCompany’s board of directors and removed the right of first negotiation infavor of Biovail with respect to acquisition transactions involving theCompany.

9

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** **

**NOTE 7.INVENTORIES**

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

 

|                 | ** ** | **March 31, 2007** | ** ** | **December 31, 2006** | ** ** |
|-----------------|------------|------------------------------|------------|---------------------------------|------------|
| Raw materials   |       | $                            | 1,119,198  |                            | $          | 1,343,421 |   |
| Work-in-process |       | 1,239,270                    |       | 1,387,359                       |       |
| Finished goods  |       | 1,392,723                    |       | 969,619                         |       |
| Deferred costs  |       | 639,643                      |       | 782,758                         |       |
| Total           |       | $                            | 4,390,834  |                            | $          | 4,483,157 |   |

 

Deferredcosts represent the costs of GLUMETZA product shipped for which recognition ofrevenue has been deferred.

**NOTE 8.SHAREHOLDERS’ EQUITY**

***Series APreferred Stock***

The Series A Preferred Stock accrued a dividendof 7% per annum, compounded semi-annually and payable in shares ofSeries A Preferred Stock. The Series A Preferred Stock wasconvertible at anytime between January 2002 and January 2006 into theCompany’s common stock. The original conversion price of the Series APreferred Stock was $12.00; however, as a result of the Company’sMarch 2002 and October 2003 financings, the conversion price had beenadjusted to $9.51 per share. In December 2004, the Company entered into anagreement with the Series A Preferred stockholder to resolve amisunderstanding between the Company and the stockholder relating primarily toprior adjustments to the conversion price of the Series A Preferred Stock.Pursuant to the agreement, among other matters, the Company agreed to adjustthe conversion price to $7.50 per share. The Company and the stockholder alsoagreed to binding interpretations of certain other terms related to theSeries A Preferred Stock conversion price.

Prior to December 2004, the amounts calculated asSeries A Preferred stock dividends were accounted for as an adjustment tothe conversion price following EITF Issue No. 98-5, *Accounting for Convertible Securities with BeneficialConversion Features or Contingently Adjustable Conversion Ratios*(IssueNo. 98-5).**As a result ofthe modifications to the preferred stock agreement in December 2004, theCompany determined that a “significant modification” of the agreement had beenmade, and, therefore, a new “commitment date” for accounting purposes had beenestablished on December 10, 2004. The Company measured the differencebetween the carrying value of the preferred stock and the fair value of themodified preferred stock pursuant to EITF Topic No. D-42, *The Effect on the Calculation of Earnings per Sharefor the Redemption or Induced Conversion of Preferred Stock* anddetermined that the fair value of the modified security was less than thecarrying value of the security prior to the modification. The Company alsoevaluated the effective conversion rate, after considering the reset rate of$7.50 per share in addition to the common stock issuable upon conversion of theunpaid, accumulated dividends. The fair value of the underlying common stock onDecember 10, 2004 was $5.06 per share. The Company determined that theconversion rate, after including the effect of the unpaid dividends, did notresult in a beneficial conversion feature, which could have had the effect ofalso providing a deemed dividend to the preferred stockholder. However, an anti-dilution provision of theSeries 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 theSeries A Preferred Stock due to additional accumulated dividends, theSeries A Preferred Stock now contains a “beneficial conversion feature”subject to recognition pursuant to Issue No. 98-5.

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** **

In conjunction with the modification of the agreement,the Company issued a warrant to the Series A Preferred stockholder. Thevalue of the warrant was considered in determining the value of the modifiedsecurity. The warrant is convertible into shares of the Company’s common stockduring the period between January 2006 and January 2009. Theconversion price of the warrant initially was $7.12, which was equal to theSeries A Preferred Stock conversion price in effect as of January 20,2006. The conversion price of the warrant decreases by approximately 4.8% peryear during the conversion period, such that the number of shares of theCompany’s common stock issuable upon conversion of the warrant will increase byapproximately 5.1% per year. The conversion of the warrant will be satisfiedonly by surrender of the outstanding shares of Series A Preferred Stock.

The Series A Preferred Stock accrued dividendsthrough January 20, 2006, which is the date the warrant initially becameexercisable. As a result of the issuance of the warrant, the preferred stockmay be surrendered in exchange for common stock for an additional three yearsthrough January 20, 2009. As long as the Series A Preferred Stockremains outstanding, the number of shares into which the warrant can beconverted increases as the conversion price of the warrant decreases resultingin additional deemed dividends on the Series A Preferred Stock. For thethree months ended March 31, 2007 and 2006, the Company recognizedSeries A Preferred Stock deemed dividends of approximately $167,000 and$173,000, respectively, attributable to the beneficial conversion feature fromthe accrued dividends and decreasing warrant price. The Company will continueto recognize Series A Preferred Stock deemed dividends until the earlierof, the time the Series A Preferred Stock is surrendered or untilJanuary 2009.

As of March 31, 2007, there were 18,158 shares ofSeries A Preferred Stock outstanding with an aggregate liquidationpreference of approximately $18,159,000. The warrant was convertible into2,705,430 shares of the Company’s common stock at a conversion price of $6.71as of March 31, 2007.

***OptionExercises***

During the three months ended March 31, 2007,employees and consultants exercised options to purchase 61,844 shares of theCompany’s common stock with net proceeds to the Company of approximately$169,000.

**NOTE 9.INCOME TAXES**

In July 2006, the Financial Accounting Standards Board, or FASB, issuedFASB Interpretation No. 48, "*Accounting for Uncertaintyin Income Taxes - an interpretation of FASB Statement No. 109*"(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an entity’s financial statements. Tax positions are evaluated forrecognition using a more-likely-than-not threshold, and those tax positionsrequiring recognition are measured as the largest amount of tax benefit that isgreater than 50 percent likely of being realized upon ultimate settlement witha taxing authority that has full knowledge of all relevant information. FIN 48is effective for fiscal years beginning after December 15, 2006. 

 

The Company adopted the provisions of FIN 48 on January 1,2007. As of the adoption date, the Company had $1.9 million ofunrecognized tax benefits. Upon adoption of FIN 48, no adjustment was madeto the Company’s liability for uncertain tax positions or the Company’sbeginning accumulated deficit balance. The adoption of FIN 48 did not havea material impact on the Company’s financial statements, results of operationsor cash flows.

 

All tax years since inception remain open to examination by theInternal Revenue Service and the California Franchise Tax Board until such timethe Company’s net operating losses and credits are either utilized or expire.Interest and penalties, if any, related to unrecognized tax benefits, would berecognized as income tax expense by the Company. As of the date of adoption ofFIN 48, the Company did not have any accrued interest or penaltiesassociated with unrecognized tax benefits. The Company does not foresee any materialchanges to unrecognized tax benefits within the next twelve months.

 

**NOTE 10.SUBSEQUENT EVENTS**

***Registered Direct Equity Offering***

In April 2007, the Company completed a registereddirect offering of 5,300,000 shares of common stock with selected institutionalinvestors. The shares were sold at a price of $3.775 per share, with netproceeds totaling approximately $20,000,000.

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** **

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

### **FORWARD-LOOKINGINFORMATION**

Statements made in this “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and elsewhere inthis Quarterly Report on Form 10-Q that are not statements of historicalfact are forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended (the Securities Act), andSection 21E of the Securities Exchange Act of 1934, as amended. We havebased these forward-looking statements on our current expectations and projectionsabout future events. Our actual results could differ materially from thosediscussed in, or implied by, these forward-looking statements. Forward-lookingstatements are identified by words such as “believe,” “anticipate,” “expect,” “intend,”“plan,” “will,” “may” and other similar expressions. In addition, anystatements that refer to expectations, projections or other characterizationsof future events or circumstances are forward-looking statements.Forward-looking statements include, but are not necessarily limited to, thoserelating to:

·             the success ofGLUMETZATM in the United States;

·             the success of ourcollaborative arrangement with King Pharmaceuticals with respect to GLUMETZA;

·             our ability to obtainmarketing partners for Gabapentin GRTM and other product candidates;

·             market acceptance ofProQuin® XR and GLUMETZA;

·             the results of ourdiscussions with Esprit Pharma related to our ProQuin XR license agreement andthe commercialization of ProQuin XR;

·             the efforts of EspritPharma with respect to the marketing of ProQuin XR;

·             the efforts ofBiovail with respect to the marketing of GLUMETZA in Canada;

·             our collaborativepartners’ compliance or non-compliance with their obligations under ouragreements with them;

·             results and timing ofour clinical trials, including the results of Gabapentin GR trials andpublication of those results;

·             our ability to raiseadditional capital; and

·             our plans to developother product candidates.

 

Factors that could causeactual results or conditions to differ from those anticipated by these andother forward-looking statements include those more fully described under “**RISK FACTORS**” in Item 1A of Part II and elsewhere inthis Quarterly Report on Form 10-Q. We disclaim any intent to update orrevise these forward-looking statements to reflect new events or circumstances.

**ABOUT DEPOMED**

Depomed is a specialtypharmaceutical company focused on the development and commercialization ofdifferentiated products that address large and growing markets and are based onproprietary oral drug delivery technologies. We have developed two commercial products.  GLUMETZA (metformin hydrochloride extendedrelease tablets) is a once-daily treatment for adults with type 2 diabetes thatwe jointly commercialize in the United States with King Pharmaceuticals,Inc.  ProQuin XR (ciprofloxacinhydrochloride extended release tablets) is a once-daily treatment foruncomplicated urinary tract infections that Esprit Pharma, Inc. markets in theUnited States.

We have a three-prongedapproach to product development designed to optimize the use and value of ourdrug delivery technologies, while managing the costs and risks associated withdeveloping and commercializing pharmaceutical products.  We develop products for our own account thatare designed to compete in large growing markets and that can be highlydifferentiated from immediate release versions of the compounds upon which theyare based.  Second, we selectively enterinto collaborative partnerships with other companies where the uniquecapabilities of our technology can provide superior value to a partner’scompound, resulting in significantly greater value for Depomed than atraditional fee-for-service arrangement. 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 tocommercialize our proprietary products, relying on partners to cover the largeprimary care audiences, while maintaining co-promotion and distribution rightsin order to be in a position to create our own sales force when appropriate,thereby increasing the value to us of our products, and our control over them.

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Our most advanced productcandidate in development is Gabapentin GR, an extended release form ofgabapentin. With respect to Gabapentin GR, we have completed enrollment of aPhase 3 clinical trial for the treatment of postherpetic neuralgia (PHN),completed and announced positive results of a Phase 2 clinical trial for thetreatment of diabetic peripheral neuropathy (DPN), and submitted aninvestigational new drug application, or IND, for a Phase 2 clinical trial forthe treatment of menopausal hot flashes. Additionally, we have other productcandidates in earlier stages of development, including a treatment forgastroesophageal reflux disease (GERD).

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

***Highlights for the Quarter EndedMarch 31, 2007***

·             In March 2007, wecompleted enrollment in our Phase 3 clinical trial for Gabapentin GR for thetreatment of postherpetic neuralgia, or PHN;

·             In March 2007, wesubmitted an Investigational New Drug application with the U.S. Food and DrugAdministration, or FDA, for Gabapentin GR for the treatment of postmenopausalhot flashes;

·             Revenue for the threemonths ended March 31, 2007 was $3.8 million compared to $1.3 million for thethree months ended March 31, 2006;

·             Operating expensesfor the three months ended March 31, 2007 were $14.8 million compared to $9.6million for the three months ended March 31, 2006;

·             Cash, cashequivalents and marketable securities were $25.8 million as of March 31, 2007compared to $33.6 million as of December 31, 2006.

 

**RECENT PRODUCT DEVELOPMENTS**

***MARKETED PRODUCTS***

***GLUMETZATM***

In April 2007, we submitted a supplemental New DrugApplication, or NDA, to the FDA covering the 1000mg GLUMETZA seeking approvalto market the product in the United States. If approved, we expect the 1000mgGLUMETZA to be available late in 2007, or in the first quarter of 2008.

*LG Life Sciences*.  In January 2007, we amended our GLUMETZAlicense agreement with LG covering Korea. We granted LG a license tomanufacture the 500mg GLUMETZA in exchange for royalties on net sales ofGLUMETZA in Korea, and removed the provisions of the original agreementproviding for the supply of 500mg GLUMETZA tablets by the Company to LG.

***ProQuin® XR***

*Esprit Pharma*.  In January 2007, we commenced discussionswith Esprit toward a mutually agreeable, long-term restructuring of our ProQuinXR license agreement with Esprit.  Thosediscussions are continuing.  Theagreement will remain in effect unless and until we and Esprit agree to anymodifications to it.

***PRODUCT CANDIDATES***

## ***Gabapentin GRTM***

*Postherpetic Neuralgia*.  In May 2006, we initiated a Phase 3 clinicaltrial for Gabapentin GR for the treatment of PHN.  The study is a randomized, double-blind,placebo-controlled study of approximately 400 PHN patients.  The study was fully enrolled in early March2007.  Patients in the study arerandomized into three treatment arms: placebo, a total daily dose of 1800mg of Gabapentin GR dosed once daily,and a total daily dose of 1800mg of Gabapentin GR dosed twice daily.

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The primary objective ofthe study is to assess the efficacy of Gabapentin GR in reducing the painassociated with PHN, measured from baseline pain scores to the end of aten-week treatment period on the basis of the Likert pain scale.  Secondary objectives include an assessment ofchanges from baseline in sleep interference, and additional patient andclinician assessments of pain and quality of life.

We expect to report theresults of the study in mid-2007.  If theresults of the study are positive, we expect to file an NDA for Gabapentin GRfor PHN in the fourth quarter of 2007.

*Menopausal Hot Flashes*.  In March 2007, we submitted to the FDA an INDfor a Phase 2 study of Gabapentin GR for the treatment of menopausal hotflashes.  The FDA did not raise anobjection to the IND application, and we commenced a Phase 2 study assessingthe safety and efficacy of Gabapentin GR for the treatment of menopausal hotflashes in April 2007.

***Gastroesophageal Reflux DiseaseProgram***

In 2006, we conducted aPhase 1 GERD study designed to provide us with insight into our formulationstrategy for our GERD program.  We are now conducting Phase 2aproof-of-concept GERD studies designed to assess our potential formulationapproach. We expect to complete these studies before the end of June2007.  Depending on those results, and interest in the project frompotential collaborative partners, we may proceed with a Phase 2 GERD study.

***OTHERRESEARCH AND DEVELOPMENT AND COLLABORATIVE PROGRAMS***

*New River*.* *In April 2007, ShirePharmaceuticals, Inc. completed its acquisition of New River Pharmaceuticals,Inc. We do not know whether the acquisition may impact our license anddevelopment agreement with New River.

*Supernus*.  In September 2006, we entered into acollaboration agreement with Supernus Pharmaceuticals, Inc. to develop througha Phase 1 study a product candidate leveraging our AcuForm drug deliverytechnology.  The cost and ownership ofthe program will be shared between the parties equally. We continue toparticipate with Supernus on this collaborative program.

*Biovail*.  In February 2007, we entered into a licenseand development agreement with Biovail granting Biovail an option to licenseour AcuForm drug delivery technology to develop and commercialize up to twopharmaceutical products. Pursuant to the agreement, Biovail paid us an upfrontfee of $500,000 in February 2007, and is contingently obligated to pay usadditional fees related to the exercise of the license option, the initiationof the first Phase 3 trial for each product and upon receipt of U.S. regulatoryapproval for each product.   Theagreement also stipulates that Biovail make royalty payments to us on netcommercial sales of any product developed under the agreement.

Also in February 2007, weamended our stock purchase agreement with Biovail, which was originally enteredinto in May 2002. The amended stock purchase agreement removed Biovail’sobserver rights on our board of directors and removed the right of first negotiationin favor of Biovail with respect to any acquisition transactions of Depomed.

**CRITICALACCOUNTING POLICIES**

Critical accountingpolicies are those that require significant judgment and/or estimates bymanagement at the time that the financial statements are prepared such thatmaterially different results might have been reported if other assumptions hadbeen made. We consider certain accounting policies related to revenuerecognition, accrued liabilities and stock-based compensation to be criticalpolicies. There have been no changes to our critical accounting policies sincewe filed our 2006 Annual Report on Form 10-K with the Securities andExchange Commission on March 16, 2007. For a description of our criticalaccounting policies, please refer to our 2006 Annual Report on Form 10-K.

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###  

### **RESULTSOF OPERATIONS**

*Three Months Ended March 31, 2007and 2006*

### **Revenue**

Total revenues aresummarized in the following table:

 

|                       | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------|------------|------------------------------------------------------|------------|
| ** **            | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Product sales:        |       |                                                 |       |   |   |
| GLUMETZA              |       | $                                                    | 1,332,000  |   | $ | — |   |
| ProQuin XR            |       | —                                               |       | 100,000 |   |
| Total product sales   |       | 1,332,000                                            |       | 100,000 |   |
|                  |       |                                                 |       |   |   |
| Royalties:            |       |                                                 |       |   |   |
| GLUMETZA              |       | 34,000                                               |       | 89,000 |   |
| ProQuin XR            |       | —                                               |       | 260,000 |   |
| Total royalties       |       | 34,000                                               |       | 349,000 |   |
|                  |       |                                                 |       |   |   |
| License revenue:      |       |                                                 |       |   |   |
| GLUMETZA              |       | 1,269,000                                            |       | 382,000 |   |
| ProQuin XR            |       | 694,000                                              |       | 511,000 |   |
| AcuForm  technology   |       | 500,000                                              |       | — |   |
| Total license revenue |       | 2,463,000                                            |       | 893,000 |   |
|                  |       |                                                 |       |   |   |
| Total revenues        |       | $                                                    | 3,829,000  |   | $ | 1,342,000 |   |

 

***Productsales***

The GLUMETZAproduct that we began selling to wholesalers and retail pharmacies in September2006 is subject to rights of return of up to twelve months after productexpiration. Given the limited sales history of GLUMETZA and return privileges,we currently cannot reliably estimate expected returns of the product at thetime of shipment.  We defer recognitionof revenue on product shipments of GLUMETZA to our customers until the right ofreturn no longer exists, which occurs at the earlier of the time GLUMETZA unitsare dispensed through patient prescriptions or expiration of the right ofreturn. We estimate the volume of prescription units dispensed by pharmaciesbased on an analysis of third-party information, including third-party marketresearch data, information obtained from certain wholesalers with respect to inventorylevels and out-movement and retail pharmacy re-stocking activity. For thequarter ended March 31, 2007, we recognized approximately $1.3 million ofproduct sales of GLUMETZA, which is net of estimated patient support programdiscounts, wholesaler fees, stocking allowances, prompt payment discounts andchargebacks. We have deferred recognition of revenue on GLUMETZA productshipments to customers which we estimate have not been dispensed throughpatient prescriptions. At March 31, 2007, we have a deferred revenue balance,which is classified as a liability on the consolidated balance sheet, of $4.0million associated with the deferral of revenue on GLUMETZA product shipments,which is net of estimated patient support program discounts, wholesaler fees,stocking allowances, prompt payment discounts and chargebacks.

ProQuin XR productsales relate to our supply agreement with Esprit. We began supplying Espritwith commercial quantities of ProQuin XR in the fourth quarter of 2005. Espritdid not make any purchases from us in the first quarter of 2007.

 

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*** ***

***Royalties***

GLUMETZA royaltiesfor quarter ended March 31, 2007 relate to royalties we received from Biovailbased on net sales of GLUMETZA in Canada and royalties we received from LGbased on net sales of GLUMETZA in Korea. GLUMETZA royalties for the quarterended March 31, 2006 relate to royalties we received on Biovail’s productlaunch of GLUMETZA in Canada.

Our agreement withEsprit provides for royalty payments by Esprit to us of 15 percent to 25percent of ProQuin XR net sales in the United States, based on escalating netsales and subject to certain minimum royalty amounts. Esprit’s minimum royaltyobligation for 2007 is $5.0 million, and in subsequent years is $5.0 millionper year, subject to annual increases in the consumer price index beginning in 2008.As a result of returns of product to Esprit, Esprit was not obligated to pay usany royalties for the quarter ended March 31, 2007. Accordingly, we recognizedno royalty revenue on ProQuin XR for the quarter ended March 31, 2007.

***Licenserevenue***

We received $25.0million in GLUMETZA license fees from Biovail in July 2005. We are recognizingthe $25.0 million license fee payment as revenue ratably until February 2023,which represents the estimated length of time our obligations exist under thearrangement related to royalties we are obligated to pay Biovail on net salesof GLUMETZA in the United States and for our obligation to use Biovail as oursole supplier of the 1000mg GLUMETZA, should the 1000mg GLUMETZA obtainapproval in the United States.

We alsoreceived a $600,000 upfront license fee from LG in August 2004 and a $500,000milestone payment received in November 2006 with respect to LG’s approval tomarket GLUMETZA in the Republic of Korea. These payments were originallydeferred and amortized as license revenue over the estimated length of timethat we were obligated to provide LG with assistance in development andmanufacturing. In January 2007, we amended our agreement with LG, granted LG alicense to manufacture the 500mg GLUMETZA in exchange for royalties on netsales of GLUMETZA in Korea, and removed the provisions of the originalagreement providing for the supply of 500mg GLUMETZA tablets by us to LG. Underthe amended agreement, we no longer have continuing performance obligationsthat are other than inconsequential or perfunctory to LG. Accordingly, theremaining $905,000 of previously deferred revenue was recognized as licenserevenue in the quarter ended March 31, 2007.

As of March 31,2007, we have received $40.0 million in license fees under our licenseagreement with Esprit for ProQuin XR.  Wereceived $30.0 million in license fees in July 2005 and an additional $10.0million in December 2006. The license fees received are being recognized as revenueratably commencing on our receipt of the fees through June 2020, whichrepresents the length of time we are obligated to manufacture ProQuin XR underour ProQuin XR supply agreement with Esprit. License revenue increased in the quarter ended March 31, 2007 over thequarter ended March 31, 2006 as a result of additional amortization of licenserevenue resulting from the receipt of the $10.0 million in December 2006.Esprit is obligated to pay us an additional $10.0 million in July 2007. ShouldEsprit not pay us the final $10.0 million license fee installment, it couldresult in a material adverse effect on our financial condition.

InFebruary 2007, we received $500,000 from Biovail upon entering into a licenseand development agreement with Biovail granting Biovail an option to licenseour AcuForm drug delivery technology to develop and commercialize up to twopharmaceutical products. We have no continuing performance obligations that areother than inconsequential or perfunctory under the agreement and haverecognized the entire upfront license fee as revenue in the quarter ended March31, 2007.

**Researchand Development Expense**

Our research anddevelopment expenses currently include costs for scientific personnel,supplies, equipment, outsourced clinical and other research activities, consultants,depreciation, facilities and utilities. The scope and magnitude of futureresearch and development expenses cannot be predicted at this time for ourproduct candidates in the early phases of research and development, as it isnot possible to determine the nature, timing and extent of clinical trials andstudies, the FDA’s requirements for a particular drug and the requirements andlevel of participation, if any, by potential partners. As potential productsproceed through the development process, each step is typically more extensive,and therefore more expensive, than the previous step. Success in developmenttherefore, generally results in increasing expenditures until actual productlaunch. Furthermore, our business strategy involves licensing certain of ourdrug candidates to collaborative partners.

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Depending upon when suchcollaborative arrangements are executed, the amount of costs incurred solely byus will be impacted. Total research and development expense for the firstquarter of 2007, as compared to the prior year, was as follows:

|                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Research and  development expense  |       | $                                                    | 8,572,000  |   | $ | 5,684,000 |   |
| Dollar change  from prior year     |       | 2,888,000                                            |       |   |   |
| Percentage change from  prior year |       | 51                                                   | %          |   |   |
|                                    |            |                                                      |            |  |  |  |  |

 

The increase in researchand development expense in the quarter ended March 31, 2007 from the quarterended March 31, 2006 was primarily due to expense related to our ongoing Phase3 clinical trials for Gabapentin GR for the treatment of postherpeticneuralgia. We expect to complete our Phase 3 clinical trial for Gabapentin GRfor the treatment of postherpetic neuralgia in 2007. Stock-based compensationincluded in research and development expense was $201,000 and $238,000 forthree months ended March 31, 2007 and 2006, respectively.

**Selling,General and Administrative Expense**

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

*** ***

|                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Selling,  general, and administrative expense |       | $                                                    | 6,227,000  |   | $ | 3,931,000 |   |
| Dollar change  from prior year                |       | 2,296,000                                            |       |   |   |
| Percentage change from  prior year            |       | 58                                                   | %          |   |   |
|                                               |            |                                                      |            |  |  |  |  |

 

The increase in selling,general and administrative expense for the quarter ended March 31, 2007 fromthe quarter ended March 31, 2006 was primarily due to approximately $0.8million in expense related to marketing costs associated with GLUMETZA, whichwas launched in September 2006, $0.2 million in promotion fees due to Kingunder the promotion agreement related to GLUMETZA and an increase of $0.8million in legal fees due to our patent infringement case against IVAXCorporation. Stock-based compensation included in selling, general andadministrative expense was $288,000 and $310,000 for three months ended March31, 2007 and 2006, respectively.

**Interest and Other Income**

 

|                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Interest and  other income         |       | $                                                    | 410,000    |   | $ | 595,000 |   |
| Dollar change  from prior year     |       | (185,000                                             | )          |   |   |
| Percentage change from  prior year |       | (31                                                  | )%         |   |   |
|                                    |            |                                                      |            |  |  |  |  |

 

Interest and other income decreased during quarterended March 31, 2007 as compared to the quarter ended March 31, 2006 as aresult of lower investment balances in 2007.

**Series APreferred Stock and Deemed Dividends**

In January 2000, we issued 12,015 shares ofSeries A Preferred Stock at a price of $1,000 per share. The Series APreferred Stock accrued a dividend of 7% per annum, compounded semi-annuallyand payable in shares of Series A Preferred Stock. The Series A PreferredStock was convertible at anytime between January 2002 andJanuary 2006 into our common stock. The original conversion price of theSeries A Preferred Stock was $12.00. However, as a result of ourMarch 2002 and October 2003 financings, the conversion price wasadjusted to $9.51 per share. In December 2004, we entered into anagreement with the Series A Preferred shareholder to resolve amisunderstanding between us and the shareholder relating primarily to prioradjustments to the conversion price of the Series A Preferred Stock (theDecember 2004 Agreement). Pursuant to the December 2004 Agreement,among other matters, we agreed to adjust the conversion price to $7.50 pershare. We and the shareholder also agreed to binding interpretations of certainother terms related to the Series A conversion price.

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Prior to December 2004, the amounts calculated asSeries A Preferred stock dividends were accounted for as an adjustment tothe conversion price following EITF Issue No. 98-5, *Accounting for Convertible Securities with BeneficialConversion Features or Contingently Adjustable Conversion Ratios*(IssueNo. 98-5).**As a result ofthe December 2004 Agreement, we determined that a significant modificationof the preferred stock agreement had occurred, and, therefore, a new commitmentdate was established for the Series A Preferred Stock. Further, wedetermined that the fair value of the modified preferred stock was below thecarrying value of such securities as of the date of the modification, therefore,no deemed dividend resulted from this modification. Also, we determined thatalthough a new commitment date had been established, this change did not resultin a beneficial conversion feature subject to recognition pursuant to EmergingIssues Task Force Issue No. 00-27, *Applicationof Issue No. 98-5 to Certain Convertible Instruments*. However,an anti-dilution provision of the Series A Preferred Stock was triggeredby our January 2005 financing, which adjusted the conversion price of theSeries A Preferred Stock to $7.12. As a result of the adjusted conversionprice and an increase in the amount of common stock issuable upon conversion ofthe Series A Preferred Stock due to additional accumulated dividends, theSeries A Preferred Stock now contains a “beneficial conversion feature”subject to recognition pursuant to Issue No. 98-5.

In conjunction with the modification of the agreement,we issued a warrant to the Series A Preferred shareholder. The value ofthe warrant was considered in determining the value of the modified security.The warrant is convertible into shares of our 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 Preferred Stockconversion price in effect as of January 20, 2006. The conversion price ofthe warrant decreases by approximately 4.8% per year during the conversionperiod, such that the number of shares of our common stock issuable uponconversion of the warrant will increase by approximately 5.1% per year. Theconversion of the warrant may be satisfied only by surrender of the outstandingshares of Series A Preferred Stock.

The Series A Preferred Stock accrued dividendsthrough January 20, 2006, the date the warrant initially became exercisable.As a result of the issuance of the warrant, the preferred stock may besurrendered in exchange for common stock for an additional three years throughJanuary 20, 2009. As long as the Series A Preferred Stock remainsoutstanding, the number of shares into which the warrant can be convertedincreases as the conversion price of the warrant decreases resulting inadditional deemed dividends on the Series A Preferred Stock. For thequarters ended March 31, 2007 and 2006, we recognized Series A PreferredStock deemed dividends of approximately $167,000 and $173,000, respectively,attributable to the beneficial conversion feature from the accrued dividendsand decreasing warrant price. We will continue to recognize Series APreferred Stock deemed dividends until the earlier of the time theSeries A Preferred Stock is surrendered or January 2009.

As ofMarch 31, 2007, there were 18,158 shares of Series A Preferred Stockoutstanding with an aggregate liquidation preference of approximately$18,159,000. The warrant was convertible into 2,705,430 shares of our commonstock at a conversion price of $6.71 as of March 31, 2007.

**LIQUIDITYAND CAPITAL RESOURCES**

** **

|                                                   | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Cash, cash  equivalents and marketable securities |       | $                        | 25,770,000 |                        | $          | 33,557,000 |   |
|                                                   |            |                          |            |                             |            |  |  |

 

Sinceinception through March 31, 2007, we have financed our product developmentefforts and operations primarily from private and public sales of equitysecurities and receipts of upfront license fees from collaborative and licensepartners. In July 2005, we received$25.0 million under our license agreement with Biovail and $30.0 million underour license agreement with Esprit. In December 2006, we received an additional$10.0 million from Esprit. Esprit is obligated to pay us an additional $10.0million in July 2007.

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InDecember 2006, we entered into a common stock purchase agreement with AzimuthOpportunity, Ltd., pursuant to which Azimuth is committed to purchase, fromtime to time and at our sole discretion, up to the lesser of (a) $30,000,000 ofour common stock, or (b) 8,399,654 shares of common stock. Sales to Azimuthunder the agreement, if any, will occur over a 24-month term and will be madeat a price equal to the average closing price of our common stock over a givenpricing period, minus a discount ranging from 3.775% to 6.375%, which variesbased on a threshold price set by us. Upon each sale of the our common stock toAzimuth under the agreement, we have also agreed to pay Reedland CapitalPartners a placement fee equal to 1.125% of the aggregate dollar amount ofcommon stock purchased by Azimuth. Azimuth is not required to purchase ourcommon stock when the price of our common stock is below $2 per share. As ofMarch 31, 2007, we have not sold any common stock to Azimuth under this commonstock purchase agreement.

In April 2007, we completed a registered directoffering of 5,300,000 shares of common stock with selected institutionalinvestors. The shares were sold at a price of $3.775 per share, with netproceeds totaling approximately $20,000,000.

As of March 31, 2007, we have accumulated net lossesof $195.0 million. We expect to continue to incur operating losses for at leastthe next year. We anticipate that our existing capital resources and contractualamounts due to us will permit us to meet our capital and operationalrequirements through at least the first quarter of 2008. We base thisexpectation on our current operating plan, which may change as a result ofmany factors.

Our cash needsmay also vary materially from our current expectations because of numerousfactors, including:

·          expenditures related toour commercialization efforts;

·          results of research anddevelopment efforts;

·          financial terms ofdefinitive license agreements or other commercial agreements we enter into, ifany;

·          receipt of payments dueto us under our contracts with collaborative partners;

·          results of ongoingdiscussions with Esprit related to the commercialization of ProQuin XR, and ourProQuin XR license agreement;

·          results of ourlitigation against IVAX Corporation;

·          changes in the focus anddirection of our research and development programs;

·          technological advances;

·          results of clinicaltesting, requirements of the FDA and comparable foreign regulatory agencies; and

·          acquisitions orinvestment in complimentary businesses, products or technologies.

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

·          conduct research anddevelopment programs;

·          conduct preclinical andclinical testing; and

·          manufacture (or havemanufactured) and market (or have marketed) potential products using theAcuForm technology.

 

Our existingcapital resources may not be sufficient to fund our operations until suchtime as we may be able to generate sufficient revenues to support ouroperations. We have limited credit facilities and except for the common stockpurchase agreement with Azimuth, we have no other committed sources of capital.To the extent that our capital resources are insufficient to meet our futurecapital requirements, we will have to raise additional funds through the saleof our equity securities or from development and licensing arrangements tocontinue our development programs. We may be unable to raise suchadditional capital on favorable terms, or at all. If we raise additionalcapital by selling our equity or convertible debt securities, the issuance ofsuch securities could result in dilution of our shareholders’ equity positions.If adequate funds are not available we may have to:

·          delay, postpone orterminate clinical trials;

·          curtail other operationssignificantly; and/or

·          obtain funds throughentering into collaboration agreements on unattractive terms.

 

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

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### **CashFlows from Operating Activities**

Cash used in operatingactivities for the three months ended March 31, 2007 was approximately $8.0million, compared to cash used in operating activities of approximately $5.8million for the three months ended March 31, 2006. During the three monthsended March 31, 2007 and 2006, cash used in operating activities was primarilydue to our net loss for the quarter adjusted for stock-based compensation,depreciation expense and movements in working capital. The increase in cashused in operating activities for the three months ended March 31, 2007 ascompared to the prior year was primarily due to an increase in net loss.

**Cash Flows from Investing Activities**

Cash used in investingactivities in the three months ended March 31, 2007 was approximately $1.6million and consisted of a net increase in marketable securities. Net cashprovided by investing activities in the three months ended March 31, 2006totaled approximately $4.8 million and consisted of a $5.0 million net decreasein marketable securities offset by $0.2 million in purchases of laboratory andoffice equipment.

**CashFlows from Financing Activities**

Cash provided by financing activities in thethree months ended March 31, 2007 was approximately$0.2 million compared to cash provided by financing activities of approximately$1.7 million for the same period in 2006. In the three months endedMarch 31, 2007, the amount consisted of cashproceeds from exercises of stock options. In the three months endedMarch 31, 2006, the amount consisted primarilyof cash proceeds from the exercises of warrants and stock options.

**Contractual Obligations**

As of March 31, 2007, our aggregate contractual obligations are asshown in the following table.

 

|                       | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Total** | ** ** |
|-----------------------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|-----------|------------|
| Operating leases      |       | $                               | 1,239,000  |               | $          | 1,883,000          |       | $         | 15,000     |   | $ | 3,137,000 |   |
| Purchase  commitments |       | 531,000                         |       | —             |       | —             |       | 531,000   |       |
|                  |       | $                               | 1,770,000  |               | $          | 1,883,000          |       | $         | 15,000     |   | $ | 3,668,000 |   |

 

AtMarch 31, 2007, we had non-cancelable purchase orders and minimum purchaseobligations of $411,000 under our manufacturing agreement with MOVAPharmaceuticals for the manufacture of GLUMETZA. The amounts disclosed onlyrepresent minimum purchase requirements. Actual purchases are expected to exceedthese amounts. We are also contractually obligated to pay PharmaNovaconsultancy fees of $120,000 under a consulting agreement related to ourGabapentin GR product candidate for the treatment of menopausal hot flashes.

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 table above 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 King.

**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

Therehave been no significant changes in our market risk compared to the disclosuresin Item 7A of our Annual Report on Form 10-K for the year endedDecember 31, 2006.

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**ITEM 4.CONTROLS AND PROCEDURES**

***Evaluation of DisclosureControls and Procedures***

Anevaluation was performed under the supervision and with the participation ofour management, including the President and Chief Executive Officer along withthe Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures as of the end of the period coveredby this quarterly report. Based on that evaluation, our management, includingthe President and Chief Executive Officer along with the Chief FinancialOfficer, concluded that our disclosure controls and procedures were effective.

Wereview and evaluate the design and effectiveness of our disclosure controls andprocedures on an ongoing basis and to improve our controls and procedures overtime and to correct any deficiencies that we may discover in the future.Our goal is to ensure that our senior management has timely access to allmaterial financial and non-financial information concerning our business. Whilewe believe the present design of our disclosure controls and procedures iseffective to achieve our goal, future events affecting our businessmay cause us to significantly modify our disclosure controls and procedures.

***Changes in InternalControls***

Therewere no changes in our internal controls over financial reporting during thequarter ended March 31, 2007 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

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**PART II — OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS**

We are involved in legalproceedings relating to some of our intellectual property rights.  InJanuary 2006, Depomed filed a complaint against IVAX Corporation in the U.S.District Court for the Northern District of California for infringement of U.S.Patent Nos. 6,340,475 and 6,635,280, both of which are owned by Depomed.  The patents relate to our AcuForm deliverytechnology. The complaint alleges infringement of our patents by IVAX’sextended release metformin hydrochloride tablet. In April 2006, IVAX filed ananswer and counterclaim, in which it alleged that the patents in the suit arenot infringed by IVAX and are invalid and unenforceable. In December 2006, thecourt issued an order construing certain of the claim terms appearing in thepatents. Discovery in the case is ongoing, and the court has not yet set adeadline for the close of discovery.

**ITEM 1A. RISK FACTORS**

In addition to other information in this report, thefollowing factors should be considered carefully in evaluating an investment inour securities. We believe the following risks and uncertainties, along withthe risks and uncertainties described above under “**MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —LIQUIDITY AND CAPITAL RESOURCES**” are the material risks anduncertainties we face at the present time. If any of the following risks oruncertainties actually occurs, our business, financial condition or results ofoperations could be materially adversely affected. There were no materialchanges to the risk factors set forth in the “Risk Factors” section of ourAnnual Report on Form 10-K for the fiscal year ended December 31,2006.

**We depend heavily on KingPharmaceuticals for the successful commercialization of GLUMETZA in the UnitedStates.**

In June 2006, we enteredinto a promotion agreement with King Pharmaceuticals pursuant to which Kingpromotes GLUMETZA in the United States through its sales force.  Under theagreement, in exchange for promotion fees, King is required to promote GLUMETZAto physicians in the United States, to deliver a minimum number of annualdetail calls to potential GLUMETZA prescribers, and to maintain a sales forceof a minimum size.  Although we haveretained rights to promote GLUMETZA to certain physicians and to retainrevenues from incremental sales generated by physicians we call upon, we havenot yet established a sales force, or contracted with a third party to act asour sales force, and we do not have immediate plans to do so.  Accordingly, the success of the initialcommercialization of GLUMETZA will depend in large part on the efforts of King’ssales force in the promotion of the product. Factors that may affect the success of our promotion arrangement withKing include the following:

·                  Kingmay acquire or develop alternative products;

·                  Kingmay pursue higher-priority programs, or change the focus of its marketingprograms;

·                  Kingmay in the future choose to devote fewer resources to GLUMETZA;

·                  GLUMETZAmay fail to achieve market acceptance; and

·                  Kingmay fail to comply with its obligations under our promotion agreement.

Any of the precedingfactors could affect King’s commitment to the collaboration, which, in turn,could adversely affect the commercial success of GLUMETZA.  Any failure to successfully commercializeGLUMETZA could have a material adverse effect on our business, financialconditions, results of operations and cash flows.

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**We are responsible for thedistribution of GLUMETZA, and we have limited experience with distribution ofpharmaceutical products.**

We are responsible forthe distribution of GLUMETZA, which is the first product that we havedistributed ourselves.  Although we haveenhanced our in-house commercial operations and distribution capabilities inconnection with the commercial launch of GLUMETZA, our internal resourcesremain limited.  In addition, we haveentered into distribution arrangements with third parties related to GLUMETZA,including Cardinal Health, AmeriSource Bergen and McKesson, and we will dependon them to ensure that GLUMETZA is widely available to support its commercialavailability.  To continue to support ourcommercialization effort related to GLUMETZA and any other product we choose tomarket and distribute, we must continue to enhance our internal commercialinfrastructure, and continue to contract with capable third parties to assistus in our commercialization efforts.  Thedevelopment of that infrastructure will also require substantial resources,which may divert the attention of our management and key personnel.  The efforts of third parties with whom wecontract for distribution of our products may not be successful.  Any failure on our part to successfullydevelop distribution capabilities could cause delays in product sales and incurincreased costs.

**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 theright to co-promote GLUMETZA and ProQuin XR through our own sales force, orthrough third parties, we have no sales force and limited marketing and salesstaff.  The success of our own promotionefforts for GLUMETZA, ProQuin XR and any other product candidates that receiveregulatory approval 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 Esprit Pharmafor the successful commercialization of ProQuin XR in the United States.**

Esprit has exclusivemarketing rights to ProQuin XR in the United States.  Esprit launched ProQuin XR inNovember 2005.  In July 2006, weagreed to extend to December 2006 the due date on the $10 millionlicense fee payment to Depomed that had been due in July 2006.  In December 2006, we did not receive thelicense fee payment on its due date, and we initiated arbitration proceedingsrelated to alleged breaches by Esprit of our license agreement with Esprit.  Later in December 2006, Esprit paid us the$10 million license fee payment and we withdrew without prejudice the noticeand demand for arbitration.  We alsoagreed to commence discussions with Esprit toward a mutually agreeable,long-term restructuring of the license agreement.  Those discussions began in January 2007 andare continuing.  The results of thosediscussions are uncertain, and we may not be able to negotiate mutuallyagreeable modifications to the license agreement.

Esprit is a private companywith a limited operating history and has not yet established a proven trackrecord of successfully commercializing its products.  In addition, Esprit has limited financialresources relative to many other pharmaceutical companies.  Any financial difficulties experienced byEsprit, or complications in the promotion of ProQuin XR or Esprit’s otherproducts, or execution of its business plan, may adversely affect theProQuin XR commercialization effort and Esprit’s ability to comply with itsobligations to us under our license agreement.

If Esprit fails tosuccessfully commercialize ProQuin XR, or to comply with its obligations underour license agreement, including its future license fee and minimum royaltyobligations, our business, financial condition and results of operations may bematerially and adversely affected.

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

We have licensedexclusive marketing rights to the 500mg GLUMETZA in Canada to Biovail, and toLG Life Sciences in Korea.  Biovaillaunched the 500mg GLUMETZA in Canada in November 2005, and LG launchedthe 500mg GLUMETZA in Korea in 2006 under the trade name Novamet GR.  We have also entered into a supply anddistribution agreement with Madaus related to the commercialization of ProQuinXR in Europe.  If Biovail or LG fail tosuccessfully commercialize GLUMETZA in Canada or Korea, respectively, or ifMadaus fails to successfully commercialize ProQuin XR in Europe, our businessand future revenues may be adversely affected.

**Our product candidates are at earlystages of development and may not be successful or achieve marketacceptance.**

We have completedenrollment of a Phase 3 clinical trial of Gabapentin GR for the treatment ofpostherpetic neuralgia, and we have completed a Phase 2 trial of Gabapentin GRfor diabetic neuropathy.  We initiated aclinical development program for Gabapentin GR for the treatment of hot flashesassociated with menopause and a clinical development program of ourgastroesophageal reflux disease product candidate. In April 2007, we submitteda prior approval supplement to the GLUMETZA NDA seeking approval to market inthe United States the 1000mg formulation of GLUMETZA, for which we have anexclusive license in the United States. We 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 arefound to be ineffective or unsafe, or otherwise may fail to receivenecessary regulatory clearances.  We areunable to predict whether any of these other product candidates will receiveregulatory clearances or be successfully manufactured or marketed.  Further, due to the extended testing andregulatory review process required before marketing clearance can be obtained,the time frames for commercialization of any products are long anduncertain.  Even if these other productcandidates receive regulatory clearance, they may not achieve or maintainmarket acceptance. Also, substantially all of our product candidates, otherthan the 1000mg formulation of GLUMETZA, use our 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.

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

To date, we have recordedlimited revenues from license fees, product sales, royalties, collaborativeresearch and development arrangements and feasibility studies. For the threemonths ended March 31, 2007, we recorded total revenues of $3.8 million, andfor the years ended December 31, 2006, 2005 and 2004, we recorded totalrevenues of $9.6 million, $4.4 million and $200,000, respectively. For thethree months ended March 31, 2007, we incurred a net loss of $10.9 million, andfor the years ended December 31, 2006, 2005 and 2004 we incurred netlosses of $39.7 million, $24.5 million and $26.9 million, respectively. As weincur expenses related to the commercialization of GLUMETZA, continue ourresearch and development efforts, preclinical testing and clinical trialactivities, and expand our sales and marketing organization, we anticipate thatwe will continue to incur substantial operating losses for at least the nextyear. 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 factorswill affect our operating results and may result in a material adverseeffect on our stock price:

·                  the degree ofcommercial success of ProQuin XR and GLUMETZA;

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

·                  results ofclinical trials for our product candidates;

·                  regulatoryactions;

·                  results oflitigation, including our pending litigation against IVAX Corporation;

·                  developmentsconcerning proprietary rights, including patents, infringement allegations andlitigation matters;

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

·                  decisions bycollaborative partners to proceed or not to proceed with subsequent phases of acollaboration or program;

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·                  marketacceptance of the AcuForm technology;

·                  adoption of newtechnologies by us or our competitors;

·                  the introductionof new products by our competitors;

·                  manufacturingcosts and difficulties;

·                  changes ingovernment funding;

·                  third-party reimbursementpolicies; and

·                  the status ofour compliance with the provisions of the Sarbanes-Oxley Act of 2002.

**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 collaboration agreement fordevelopment of product candidates through the feasibility phase with New RiverPharmaceuticals, and we have a collaboration arrangement with Patheon, Inc.related to the potential development of product candidates for thirdparties.  We also have a collaborationagreement with Supernus, Inc. providing for the development of a productcandidate through feasibility, with the possibility to enter into a definitiveagreement providing for the further development of the product candidate byeither or both parties.  In addition, wehave in the past and may in the future enter into other collaborative arrangements,some of which have been based on less definitive agreements, such as memorandaof understanding, 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 patents by third parties.Moreover, negotiating collaborative arrangements often takes considerablylonger to conclude than the parties initially anticipate, which could cause usto agree to less favorable agreement terms that delay or defer recovery of ourdevelopment costs and reduce 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:

·                  anyparallel development by a collaborative partner of competitive technologies orproducts;

·                  arrangementswith collaborative partners that limit or preclude us from developing productsor technologies;

·                  prematuretermination of a collaboration agreement; or

·                  failureby a collaborative partner to devote sufficient resources to the developmentand commercial sales of products using 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.

 

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**We may be unable to protect our intellectual propertyand may be liable for infringing the intellectual property of others.**

Our success will depend in part on our ability toobtain and maintain patent protection for our technologies and to preserve ourtrade secrets. Our policy is to seek to protect our proprietary rights, byamong other methods, filing patent applications in the United States andforeign jurisdictions to cover certain aspects of our technology. We currentlyhold nine issued patents, and have fourteen patent applications pending in theUnited States.  In addition, we arepreparing patent applications relating to our expanding technology for filingin the United States and abroad.  We havealso applied for patents in numerous foreign countries. Some of those countrieshave granted our applications and other applications are still pending. Ourpending patent applications may lack priority over others’ applications or maynot result in the issuance of patents. Even if issued, our patents may not besufficiently broad to provide protection against competitors with similartechnologies and may be challenged, invalidated or circumvented, which couldlimit our ability to stop competitors from marketing related products or maynot provide us with competitive advantages against competing products. We alsorely on trade secrets and proprietary know-how, which are difficult to protect.We seek to protect such information, in part, through entering intoconfidentiality agreements with employees, consultants, collaborative partnersand others before such persons or entities have access to our proprietary tradesecrets and know-how. These confidentiality agreements may not be effective incertain cases, due to, among other things, the lack of an adequate remedy forbreach of an agreement or a finding that an agreement is unenforceable. Inaddition, our trade secrets may otherwise become known or be independentlydeveloped by competitors.

Our ability to develop our technologies and to makecommercial sales of products using our technologies also depends on notinfringing others’ patents or other intellectual property rights. We are notaware of any intellectual property claims against us.  However, the pharmaceutical industry hasexperienced extensive litigation regarding patents and other intellectualproperty rights. For example, we areaware that patents issued to third parties relating to sustained release drugformulations or particular pharmaceutical compounds could in the future beasserted against us, although we believe that we do not infringe any validclaim of any patents.  If claimsconcerning any of our products were to arise and it was determined that theseproducts infringe a third party’s proprietary rights, we could be subject tosubstantial damages for past infringement or be forced to stop or delay ouractivities with respect to any infringing product, unless we can obtain alicense, or we may have to redesign our product so that it does not infringeupon others’ patent rights, which may not be possible or could requiresubstantial funds or time.  Such alicense may not be available on acceptable terms, or at all.  Even if we, our collaborators or ourlicensors were able to obtain a license, the rights may be nonexclusive, whichwould give our competitors access to the same intellectual property.  In addition, any public announcements relatedto litigation or interference proceedings initiated or threatened against us,even if such claims are without merit, could cause our stock price to decline.

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

In January 2006, wefiled a complaint against IVAX Corporation in federal court for infringement oftwo of our U.S. patents related to the AcuForm delivery technology.  The complaint alleged infringement of ourpatents by IVAX’s extended release metformin hydrochloride tablet. Although weintend to vigorously enforce our intellectual property rights, litigation isexpensive and unpredictable and there can be no assurance that we will besuccessful in our litigation against IVAX. If one or more of our patents is declared invalid or key claims aredisallowed, the patent protection for our products and product candidates couldbe substantially weakened and our business and business prospects could beseverely impacted.

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

We have an exclusive sublicense from PharmaNova, Inc.to a patent held by the University of Rochester to develop and commercialize inthe United States a gabapentin product for the treatment of hot flashesassociated with menopause in women. Because a method-of-use patent, such as the patent we have sublicensedfrom PharmaNova, covers only a specified use of a particular compound, not aparticular composition of matter, we cannot prevent others from commercializinggabapentin.  Accordingly, physicianscould prescribe another manufacturer’s gabapentin to treat hot flashes inmenopausal women rather than Gabapentin GR, or pharmacists could seek to fillprescriptions for Gabapentin 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 we do notdevelop a successful product we may not be able to raise additional funds.**

The drug developmentprocess is costly, time-consuming and subject to unpredictable delays andfailures. Before we or others make commercial sales of products using theAcuForm technology, other than GLUMETZA and ProQuin XR, we, our currentand any future collaborative partners will need to:

·                  conductpreclinical and clinical tests showing that these products are safe andeffective; and

·                  obtainregulatory approval from the FDA or foreign regulatory authorities.

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

·                  theAcuForm technology has unintended or undesirable side effects; or

·                  productcandidates that appear promising in preclinical or early-stage clinical studiesdo not demonstrate efficacy in later-stage, larger scale clinical trials.

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

·                  marketacceptance;

·                  cost-effectivecommercial scale production; and

·                  reimbursementunder private or governmental health plans.

Any material delay orfailure in the governmental approval process and/or the successfulcommercialization of our potential products would adversely impact ourfinancial position and liquidity and would make it difficult for us to raisefinancing on favorable terms, if at all.

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**If we do not achieve our projecteddevelopment and commercialization goals in the timeframes we announce andexpect, the commercialization of our product candidates may be delayed and ourbusiness will be harmed and our stock price may decline.**

For planning purposes, weestimate 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 our ongoing Phase 3 clinical trial of Gabapentin GR, or theinitiation of other clinical programs. All of these milestones are based on avariety of assumptions.  The actualtiming of these milestones can vary considerably from our estimates dependingon numerous factors, some of which are beyond our control, including:

·                  ouravailable capital resources;

·                  theefforts of our marketing partners with respect to the commercialization of ourproducts;

·                  therate of progress, costs and results of our clinical trial and research anddevelopment activities, including the extent of scheduling conflicts withparticipating clinicians and clinical institutions and our ability to identifyand enroll patients who meet clinical trial eligibility criteria;

·                  ourreceipt of approvals by the FDA and other regulatory agencies and the timingthereof;

·                  otheractions by regulators;

·                  ourability to access sufficient, reliable and affordable supplies of componentsused in the manufacture of our product candidates, including insulin andmaterials for our AcuForm technology; and

·                  thecosts of ramping up and maintaining 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 andclinical sites to enroll patients in our clinical trials and other thirdparties to manage the trials and to perform related data collection andanalysis, and, as a result, we may face costs and delays outside of ourcontrol.**

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

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.

**Pharmaceuticalmarketing is 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 theUnited States is uncertain and may limit our ability to develop, manufactureand sell our products internationally.**

To market any of our products outside of the UnitedStates, we and our collaborative partners, including Madaus, which has theexclusive rights to commercialize ProQuin XR in Europe, are subject to numerousand varying foreign regulatory requirements, implemented by foreign health authorities,governing the design and conduct of human clinical trials and marketingapproval for drug products. The approval procedure varies among countries andcan involve additional testing, and the time required to obtain approval maydiffer 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.

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**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:

·                  governmenthealth administration authorities;

·                  privatehealth insurers;

·                  healthmaintenance organizations;

·                  pharmacybenefit management companies; and

·                  otherhealthcare-related organizations.

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.

**We may be unable to compete successfully in thepharmaceutical product and drug delivery system industries.**

Other companies that have oral drug deliverytechnologies competitive with the AcuForm technology include Bristol-MyersSquibb, IVAX Corporation (a subsidiary of TEVA Pharmaceutical Industries,Ltd.), ALZA Corporation (a subsidiary of Johnson & Johnson),SkyePharma plc, Biovail Corporation, Flamel Technologies S.A., RanbaxyLaboratories, 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-Myers Squibb is currently marketing a sustainedrelease formulation of metformin, Glucophage XR, with which GLUMETZAcompetes. The limited license that Bristol-Myers Squibb obtained from us underour November 2002 settlement agreement extends to certain current andinternally-developed future compounds, which may increase the likelihoodthat we will face competition from Bristol-Myers Squibb in the future onproducts in addition to GLUMETZA. Several other companies, including BarrPharmaceuticals, Inc., Mylan Laboratories, Inc. and TevaPharmaceutical Industries, Ltd. have received FDA approval for and are sellinga controlled-release metformin product. Flamel Technologies has acontrolled-release microparticle-based formulation of metformin product inPhase 2 clinical trials.

Bayer Corporation developed a once-daily ciprofloxacinproduct for the treatment of urinary tract infections, which is currentlymarketed by Schering-Plough Corporation. There may be other companiesdeveloping products competitive with GLUMETZA and ProQuin XR of which we areunaware.

Gabapentin is currently marketed by Pfizer asNeurontin for adjunctive therapy for epileptic seizures and for postherpeticpain. Pfizer’s basic U.S. patents relating to Neurontin have expired, and atleast seven companies have received approval to market generic versions of theimmediate release product. In addition, Pfizer has developed a new product,LyricaTM (pregabalin), which has been approved for marketing in the U.S. and theEuropean Union.

Competition in pharmaceutical products and drugdelivery systems is intense. We expect competition to increase. Competingtechnologies or products developed in the future may prove superior to theAcuForm technology or products using the AcuForm technology, eithergenerally or in particular market segments. These developments could make theAcuForm technology or products using the AcuForm technologynoncompetitive or obsolete.

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

**We depend on third parties who aresingle source suppliers to manufacture ProQuin XR, GLUMETZA and our later stageproduct candidates.  If these suppliersare unable to manufacture ProQuin XR, GLUMETZA or our product candidates, ourbusiness will be harmed.**

We are responsible for the supply and distribution ofGLUMETZA. MOVA Pharmaceuticals, a subsidiary of Patheon, Inc., is our solesupplier for tablets of the 500mg strength of GLUMETZA pursuant to a supplyagreement we entered into with MOVA Pharmaceuticals in December 2006.  We purchase the active ingredient for the500mg GLUMETZA from Farmhispania, S.A., a sole supplier to us, on a purchaseorder basis.  If the new formulation of1000mg GLUMETZA is approved, we will rely on Biovail as our sole supplier.  We will be unable to supply GLUMETZA in atimely manner if we are unable to obtain GLUMETZA 500mg tablets from ourcontract manufacturer or active pharmaceutical ingredient from suppliers, orGLUMETZA 1000mg tablets from Biovail.

We are also responsible for supplying commercialquantities of ProQuin XR to Esprit.  Forthe manufacture of ProQuin XR tablets, we have entered into an agreement withMOVA Pharmaceuticals, as our sole supplier. Uquifa Mexico, S.A., our supplier of the active pharmaceuticalingredient to ProQuin XR, is also a sole supplier to us.  We obtain the active pharmaceuticalingredient to ProQuin XR on a purchase order basis only.  We will also be responsible for themanufacture of bulk ProQuin XR tablets to Madaus for the European market, ifthe product is approved for marketing in European jurisdictions.  We intend to purchase ProQuin XR tablets fromMOVA Pharmaceuticals for that purpose. If we are unable, for whatever reason,to obtain the active pharmaceutical ingredient or ProQuin XR tablets from ourcontract manufacturers, we may be unable to manufacture ProQuin XR in a timelymanner, 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 could become subject to product liability litigation andmay not have adequate insurance to cover product liability claims.**

Our business involves exposure to potential productliability risks that are inherent in the production and manufacture ofpharmaceutical products. We have obtained product liability insurance forclinical trials currently underway and forecasted 2007 sales of our products, but:

·                  we may beunable to obtain product liability insurance for future trials;

·                  we may beunable to obtain product liability insurance for future products;

·                  we may beunable to maintain product liability insurance on acceptable terms;

·                  we may beunable to secure increased coverage as the commercialization of theAcuForm technology proceeds; or

·                  our insurancemay not provide adequate protection against potential liabilities.

Our inability to obtain adequate insurance coverage atan acceptable cost could prevent or inhibit the commercialization of ourproducts. Defending a lawsuit would be costly and significantly divertmanagement’s attention from conducting our business. If third parties were tobring a successful product liability claim or series of claims against usfor uninsured liabilities or in excess of insured liability limits, ourbusiness, financial condition and results of operations could be materiallyharmed.

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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 customer demands,competitive pressures and technologies. Accordingly, we may in the futurepursue the acquisition of complementary businesses, products or technologiesinstead of developing them ourselves. We have no current commitments withrespect to any acquisition or such investment. We do not know if we would beable to successfully complete any acquisitions, or whether we would be able tosuccessfully integrate any acquired business, product or technology or retainany key employees. Integrating any business, product or technology we acquirecould be expensive and time consuming, disrupt our ongoing business anddistract our management. If we were to be unable to integrate any acquiredbusinesses, products or technologies effectively, our business would suffer. Inaddition, any amortization or charges resulting from the costs of acquisitionscould harm our operating results.

**If we lose our key personnel or are unable toattract and retain key management and operating personnel, we may beunable to pursue our product development and commercialization efforts.**

Our success is dependent in large part upon thecontinued services of John W. Fara, Ph.D., our Chairman, President and ChiefExecutive Officer, Carl A. Pelzel, our Executive Vice President and ChiefOperating Officer, and other members of our executive management team, and onour ability to attract and retain key management and operating personnel. We donot have agreements with Dr. Fara, Mr. Pelzel or any of our otherexecutive officers that provide for their continued employment with us.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.

**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 ofSection 1203 of the California General Corporation Law which requires afairness opinion to be provided to our shareholders in connection with theirconsideration of any proposed “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 withcorporate governance compliance may significantly impact our results ofoperations.**

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.

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**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 stock purchaseagreement with Azimuth Opportunity Ltd., pursuant to which we may sell sharesof common stock at a discount to the prevailing market price ranging from3.775% to 6.375%, excluding an additional placement agent fee of 1.125% payableby us on the gross offering proceeds. In addition, as other capital raisingopportunities present themselves, we may enter into financing or similararrangements in the future, including the issuance of debt securities,preferred stock or common stock. If we issue common stock or securitiesconvertible into common stock, our common shareholders will experience dilutionand this dilution will be greater if we find it necessary to sell securities ata discount to prevailing market prices.

**If we are unable to satisfyregulatory requirements relating to internal controls, our stock price couldsuffer.**

Section 404 of the Sarbanes-Oxley Act of 2002 requirescompanies to conduct a comprehensive evaluation of their internal control over financial reporting.  At the end of each fiscal year, we mustperform an evaluation of our internal control over financial reporting, includein our annual report the results of the evaluation, and have our externalauditors publicly attest to such evaluation. If material weaknesses were found in our internal controls in thefuture, if we fail to complete future evaluations on time, or if our externalauditors cannot attest to our future evaluations, we could fail to meet ourregulatory reporting requirements and be subject to regulatory scrutiny and aloss of public confidence in our internal controls, which could have an adverseeffect on our stock price.

**Businessinterruptions could limit our 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.

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

Notapplicable.

**ITEM 3.****  DEFAULTS UPON SENIORSECURITIES**

Notapplicable.

**ITEM 4.****  SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

Notapplicable.

**ITEM 5.  OTHERINFORMATION**

Notapplicable.

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**ITEM 6.EXHIBITS**

 
| (a)    |   | **Exhibits** |   |                                                                                                                  |
|--------|--------|--------------|--------|-----------------------------------------------------------------------------------------------------------------------|
|   |   | 31.1         |   | Certification pursuant to  Rule 13a-14(a) under the Securities Exchange Act of 1934 of John W.  Fara, Ph.D. |
|   |   |         |   |                                                                                                                  |
|   |   | 31.2         |   | Certification pursuant to  Rule 13a-14(a) under the Securities Exchange Act of 1934 of John F.  Hamilton    |
|   |   |         |   |                                                                                                                  |
|   |   | 32.1         |   | Certification pursuant to 18 U.S.C.  Section 1350 of John W. Fara, Ph.D.                                         |
|   |   |         |   |                                                                                                                  |
|   |   | 32.2         |   | Certification pursuant to 18 U.S.C.  Section 1350 of John F. Hamilton                                            |

 

 

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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 9, 2007 |   | DEPOMED, INC.      |
|-------------------|--------|-------------------------|
|              |   |                    |
|              |   |                    |
|              |   | By:                     | /s/ John F. Hamilton |   |
|              |   | John F. Hamilton        |
|              |   | Vice President and      |
|              |   | Chief Financial Officer |
|              |   | (Authorized Officer and |
|              |   | Principal Accounting    |
|              |   | and Financial Officer)  |
|              |   |                    |
|              |   |                    |
|              |   | By:                     | /s/ John W. Fara, Ph.D. |   |
|              |   | John W. Fara, Ph.D.     |
|              |   | President, Chairman and |
|              |   | Chief Executive Officer |
|                   |        |                         |  |  |  |

 

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