Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

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

#### ** **

| **x**                                                                                                                                          | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                           |
| **FOR THE QUARTERLY PERIOD ENDED  September 30, 2009**                                                                                    |
|                                                                                                                                           |
| **OR**                                                                                                                                         |
|                                                                                                                                           |
| **o**                                                                                                                                          | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|                                                                                                                                           |
| **FOR THE TRANSITION PERIOD FROM           TO          ** |

 

**COMMISSION FILE NUMBER 001-13111**

 

**DEPOMED, INC.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

 

**1360 O’BRIEN DRIVE**

**MENLO PARK, CALIFORNIA 94025**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

 

**(650) 462-5900**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

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

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).   Yes  o   No  o

 

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

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

 

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

 

Thenumber of issued and outstanding shares of the Registrant’s Common Stock, nopar value, as of November 5, 2009 was 52,011,261.

 

 

 

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Table ofContents

 

**DEPOMED, INC.**

 
| ** **                                                                                                           | **PAGE**   |
|----------------------------------------------------------------------------------------------------------------------|------------|
|                                                                                                                 |       |
| **PART I — FINANCIAL INFORMATION**                                                                         | ** ** |
|                                                                                                                 |       |
| Item  1. Condensed Financial Statements:                                                                             |       |
|                                                                                                                 |       |
| Condensed Balance Sheets at September 30, 2009  (unaudited) and December 31, 2008                          | 3          |
|                                                                                                                 |       |
| Condensed Statements of Operations for the three and  nine months ended September 30, 2009 and 2008 (unaudited) | 4          |
|                                                                                                                 |       |
| Condensed Statements of Cash Flows for the nine months  ended September 30, 2009 and 2008 (unaudited)           | 5          |
|                                                                                                                 |       |
| Notes to Condensed Financial Statements (unaudited)                                                                  | 6          |
|                                                                                                                 |       |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                  | 18         |
|                                                                                                                 |       |
| Item 3. Quantitative and Qualitative Disclosure About  Market Risk                                                   | 30         |
|                                                                                                                 |       |
| Item 4. Controls and Procedures                                                                                      | 30         |
|                                                                                                                 |       |
| **PART II  — OTHER INFORMATION**                                                                           | ** ** |
|                                                                                                                 |       |
| Item  1. Legal Proceedings                                                                                           | 31         |
|                                                                                                                 |       |
| Item  1A. Risk Factors                                                                                               | 31         |
|                                                                                                                 |       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                                 | 42         |
|                                                                                                                 |       |
| Item 3. Defaults upon Senior Securities                                                                              | 42         |
|                                                                                                                 |       |
| Item 4. Submission of Matters to a Vote of Security  Holders                                                         | 42         |
|                                                                                                                 |       |
| Item  5. Other Information                                                                                           | 42         |
|                                                                                                                 |       |
| Item 6.  Exhibits                                                                                                    | 43         |
|                                                                                                                 |       |
| Signatures                                                                                                           | 44         |

 

2

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Table of Contents

 

**PART I— FINANCIAL INFORMATION**

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

###### ** **

**DEPOMED, INC.**

**CONDENSEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                  | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                                                                                  | ** ** | **(Unaudited)**        | ** ** | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                  | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                                                                             |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                   |       | $                      | 17,650     |                  | $          | 22,127 |   |
| Marketable securities                                                                                                                                                                                                                                       |       | 53,338                 |       | 59,932                |       |
| Accounts receivable                                                                                                                                                                                                                                         |       | 5,042                  |       | 3,099                 |       |
| Unbilled accounts receivable                                                                                                                                                                                                                                |       | 441                    |       | 576                   |       |
| Inventories                                                                                                                                                                                                                                                 |       | 2,154                  |       | 2,849                 |       |
| Prepaid and other current assets                                                                                                                                                                                                                            |       | 972                    |       | 5,404                 |       |
| Total current assets                                                                                                                                                                                                                                        |       | 79,597                 |       | 93,987                |       |
| Marketable securities                                                                                                                                                                                                                                       |       | 17,660                 |       | —                |       |
| Property and equipment, net                                                                                                                                                                                                                                 |       | 1,033                  |       | 900                   |       |
| Other assets                                                                                                                                                                                                                                                |       | 197                    |       | 197                   |       |
|                                                                                                                                                                                                                                                        |       | $                      | 98,487     |                  | $          | 95,084 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                              | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                                                                                        |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                            |       | $                      | 2,853      |                  | $          | 559 |   |
| Accrued compensation                                                                                                                                                                                                                                        |       | 1,879                  |       | 2,601                 |       |
| Accrued clinical trial expense                                                                                                                                                                                                                              |       | 2,242                  |       | 661                   |       |
| Other accrued liabilities                                                                                                                                                                                                                                   |       | 9,739                  |       | 9,027                 |       |
| Deferred product sales                                                                                                                                                                                                                                      |       | 1,604                  |       | 1,702                 |       |
| Deferred license revenue                                                                                                                                                                                                                                    |       | 10,684                 |       | 4,362                 |       |
| Other current liabilities                                                                                                                                                                                                                                   |       | 103                    |       | 110                   |       |
| Current portion of long-term debt                                                                                                                                                                                                                           |       | 3,636                  |       | 3,356                 |       |
| Total current liabilities                                                                                                                                                                                                                                   |       | 32,740                 |       | 22,378                |       |
| Deferred license revenue, non-current portion                                                                                                                                                                                                               |       | 43,977                 |       | 33,209                |       |
| Long-term debt, non-current portion                                                                                                                                                                                                                         |       | 3,149                  |       | 5,775                 |       |
| Other long-term liabilities                                                                                                                                                                                                                                 |       | 510                    |       | 569                   |       |
| Commitments                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Shareholders’ equity:                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Preferred stock, no par value, 5,000,000 shares  authorized; Series A convertible preferred stock, 25,000 shares  designated, 18,158 shares issued and surrendered, and zero shares outstanding  at September 30, 2009 and December 31, 2008 |       | —                 |       | —                |       |
| Common stock, no par value, 100,000,000 shares  authorized; 51,751,099 and 51,171,377 shares issued and outstanding at  September 30, 2009 and December 31, 2008, respectively                                                                    |       | 186,526                |       | 183,196               |       |
| Accumulated deficit                                                                                                                                                                                                                                         |       | (168,591               | )          | (150,194              | )          |
| Accumulated other comprehensive gain                                                                                                                                                                                                                        |       | 176                    |       | 151                   |       |
| Total shareholders’ equity                                                                                                                                                                                                                             |       | 18,111                 |       | 33,153                |       |
|                                                                                                                                                                                                                                                        |       | $                      | 98,487     |                  | $          | 95,084 |   |

 

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(1) Derived from the audited financial statements included in theCompany’s Annual Report on Form 10-K for the year ended December 31,2008.

 

See accompanying notes to CondensedFinancial Statements.

 

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**DEPOMED, INC.**

**CONDENSED STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                          | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                                                           | ** ** | ** **                                | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product sales                                                                       |       | $                                         | 9,859      |                                     | $          | 13,011 |   | $ | 25,107 |   | $ | 23,756 |   |
| Royalties                                                                           |       | 464                                       |       | 516                                      |       | 1,457 |   | 1,060 |   |
| License and collaborative revenue                                                   |       | 12,691                                    |       | 584                                      |       | 17,930 |   | 1,311 |   |
| Total revenues                                                                      |       | 23,014                                    |       | 14,111                                   |       | 44,494 |   | 26,127 |   |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Costs and expenses:                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| Cost of sales                                                                       |       | 1,367                                     |       | 2,396                                    |       | 3,628 |   | 4,567 |   |
| Research and development                                                            |       | 9,300                                     |       | 6,998                                    |       | 29,345 |   | 17,748 |   |
| Selling, general and administrative                                                 |       | 10,931                                    |       | 5,250                                    |       | 29,878 |   | 16,998 |   |
| Gain on litigation settlement                                                       |       | —                                    |       | —                                   |       | — |   | (7,500 | ) |
| Total costs and expenses                                                            |       | 21,598                                    |       | 14,644                                   |       | 62,851 |   | 31,813 |   |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Income (loss) from operations                                                       |       | 1,416                                     |       | (533                                     | )          | (18,357 | ) | (5,686 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Other income (expense):                                                             |       |                                      |       |                                     |       |   |   |   |   |
| Interest and other income                                                           |       | 181                                       |       | 515                                      |       | 731 |   | 1,871 |   |
| Interest expense                                                                    |       | (240                                      | )          | (249                                     | )          | (788 | ) | (254 | ) |
| Total other income (expense)                                                        |       | (59                                       | )          | 266                                      |       | (57 | ) | 1,617 |   |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) before income taxes                                               |       | 1,357                                     |       | (267                                     | )          | (18,414 | ) | (4,069 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Provision for income taxes                                                          |       | 16                                        |       | (4                                       | )          | 17 |   | (4 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss)                                                                   |       | 1,373                                     |       | (271                                     | )          | (18,397 | ) | (4,073 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Deemed dividend on preferred stock                                                  |       | —                                    |       | (183                                     | )          | — |   | (538 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) applicable to common stock  shareholders                          |       | $                                         | 1,373      |                                     | $          | (454 | ) | $ | (18,397 | ) | $ | (4,611 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Basic net income (loss) applicable to common stock  shareholders per common share   |       | $                                         | 0.03       |                                     | $          | (0.01 | ) | $ | (0.36 | ) | $ | (0.10 | ) |
| Diluted net income (loss) applicable to common stock  shareholders per common share |       | $                                         | 0.03       |                                     | $          | (0.01 | ) | $ | (0.36 | ) | $ | (0.10 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |
| Shares used in computing basic net income (loss) per  common share                  |       | 51,598,316                                |       | 48,123,668                               |       | 51,357,924 |   | 48,011,004 |   |
| Shares used in computing diluted net income (loss)  per common share                |       | 52,459,484                                |       | 48,123,668                               |       | 51,357,924 |   | 48,011,004 |   |

 

See accompanying notes to Condensed Financial Statements.

 

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**DEPOMED, INC.**

**CONDENSED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| **Operating Activities**                                                                   | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                                         | (18,397    | ) | $ | (4,073 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                                      |       |   |   |
| Depreciation and amortization                                                              |       | 786                                       |       | 890 |   |
| Employee and director stock-based compensation                                             |       | 2,083                                     |       | 1,752 |   |
| Stock-based compensation related to consultants                                            |       | 33                                        |       | 198 |   |
| Changes in assets and liabilities:                                                         |       |                                      |       |   |   |
| Accounts receivable                                                                        |       | (1,808                                    | )          | (500 | ) |
| Inventories                                                                                |       | 694                                       |       | 255 |   |
| Prepaid and other current assets                                                           |       | 4,432                                     |       | (693 | ) |
| Accounts payable and other accrued liabilities                                             |       | 4,522                                     |       | 3,357 |   |
| Accrued compensation                                                                       |       | (722                                      | )          | 375 |   |
| Deferred revenue                                                                           |       | 16,992                                    |       | 5,637 |   |
| Net cash provided by operating activities                                                  |       | 8,615                                     |       | 7,198 |   |
|                                                                                       |       |                                      |       |   |   |
| **Investing Activities**                                                                   | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                        |       | (634                                      | )          | (230 | ) |
| Purchases of marketable securities                                                         |       | (118,202                                  | )          | (82,758 | ) |
| Maturities of marketable securities                                                        |       | 94,951                                    |       | 54,991 |   |
| Sales of marketable securities                                                             |       | 11,999                                    |       | 11,159 |   |
| Net cash used in investing activities                                                      |       | (11,886                                   | )          | (16,838 | ) |
|                                                                                       |       |                                      |       |   |   |
| **Financing Activities**                                                                   | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Proceeds from long-term debt                                                               |       | —                                    |       | 9,400 |   |
| Principal payments on long-term debt                                                       |       | (2,419                                    | )          | — |   |
| Debt issuance costs                                                                        |       | —                                    |       | (303 | ) |
| Proceeds from issuance of common stock                                                     |       | 1,213                                     |       | 289 |   |
| Net cash (used in) provided by financing activities                                        |       | (1,206                                    | )          | 9,386 |   |
|                                                                                       |       |                                      |       |   |   |
| Net decrease in cash and cash equivalents                                                  |       | (4,477                                    | )          | (254 | ) |
| Cash and cash equivalents at beginning of period                                           |       | 22,127                                    |       | 14,374 |   |
| Cash and cash equivalents at end of period                                                 |       | $                                         | 17,650     |   | $ | 14,120 |   |

 

See accompanying notes to Condensed Financial Statements.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

## ***Basis of Presentation***

## * *

These unaudited condensed financial statements and therelated footnote information of Depomed, Inc. (the Company or Depomed)have been prepared pursuant to the requirements of the Securities and ExchangeCommission (SEC) for interim reporting. As permitted under those rules andregulations, certain footnotes or other financial information that are normallyrequired by U.S. generally accepted accounting principles have been condensedor omitted pursuant to such rules and regulations. In the opinion of theCompany’s management, the accompanying interim unaudited condensed financialstatements include all adjustments (consisting only of normal recurringadjustments) necessary for a fair presentation of the information for theperiods presented. The results for the interim period ended September 30,2009 are not necessarily indicative of results to be expected for the entireyear ending December 31, 2009 or future operating periods.

 

In June 2009,the Financial Accounting Standards Board (FASB), issued the FASB AccountingStandards Codification (the Codification). Effective this quarter, theCodification became the single source for all authoritative U.S. generallyaccepted accounting principles (GAAP) recognized by the FASB. The Codificationis required to be applied to financial statements issued for interim and annualperiods ending after September 15, 2009. The Codification does not changeGAAP and did not impact the Company’s financial position or results ofoperations.

 

The balance sheet as of December 31, 2008 hasbeen derived from the audited financial statements at that date. The balancesheet does not include all of the information and footnotes required by U.S.generally accepted accounting principles for complete financial statements. Forfurther information, refer to the financial statements and footnotes theretoincluded in the Company’s annual report on Form 10-K for the year ended December 31,2008 filed with the SEC.

 

***Use of Estimates***

 

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

 

***Revenue Recognition***

 

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

 

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

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

·                  Product Sales:

 

·                  *GLUMETZA**®*: The Company began selling GLUMETZA*®* (metformin hydrochloride extended releasetablets) in August 2006 to wholesalers and retail pharmacies that issubject to rights of return six months before expiration and up to twelvemonths after product expiration. Beginning in the third quarter of 2008, theCompany began recognizing revenue for GLUMETZA sales at the time title transfersto its customers, which occurs at the time product is delivered to itscustomers.  Prior to the third quarter of2008, the Company was unable to reasonably estimate expected returns of theproduct at the time of shipment, and therefore deferred revenue on productshipments of GLUMETZA until the product was dispensed through patientprescriptions. The quantity of prescription units dispensed was estimated basedon an analysis of third-party information, including third-party marketresearch data and information obtained from wholesalers with respect toinventory levels and inventory movement. Based on the actual shipment trends,prescription trends and product returns history for GLUMETZA, as well as ananalysis of return rates of companies with products that have similarcharacteristics and similar return policies within the metformin prescriptionmarket, the Company concluded it had the information needed to reasonablyestimate product returns beginning in the third quarter of 2008. Consequently,in the third quarter of 2008, the Company recognized a one time increase of$6.3 million in net product sales of GLUMETZA, representing product salespreviously deferred, net of estimated product returns, managed care andMedicaid rebates, wholesaler discounts and retail pharmacy discounts,chargebacks and prompt pay discounts.

 

·                  *Proquin**®XR*: The Company sells Proquin® XR (ciprofloxacinhydrochloride) to wholesalers and retail pharmacies that is subject to rightsof return six months before expiration and up to twelve months after productexpiration.  Given the Company’s limitedhistory of selling Proquin XR, the Company currently cannot reliably estimateexpected returns of the product at the time of shipment. Accordingly, theCompany defers recognition of revenue on product shipments of Proquin XR untilthe right of return no longer exists, which occurs at the earlier of the timeProquin XR units are dispensed through patient prescriptions or expiration ofthe right of return. The Company estimates patient prescriptions dispensedusing an analysis of third-party information, including third-party marketresearch data and information obtained from wholesalers with respect toinventory levels and inventory movement. As a result of this policy, theCompany has a deferred revenue balance of $1.6 million at September 30,2009 related to Proquin XR product shipments that have not been recognized asrevenue, which is net of wholesaler fees, retail pharmacy discounts and promptpayment discounts. The Company will recognize revenue upon the earlier to occurof prescription units dispensed or the expiration of the right of return untilit can reliably estimate product returns, at which time the Company will recorda one-time increase in net revenue related to the recognition of revenuepreviously deferred. In addition, the costs of manufacturing Proquin XRassociated with the deferred revenue are recorded as deferred costs, which areincluded in inventory, until such time the related deferred revenue isrecognized.

 

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

 

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

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

·                  ProductReturns — The Company estimates product returns on sales of GLUMETZA. TheCompany allows customers to return product that is within six months before andup to one year after its product expiration date.  The shelf life of the 500mg GLUMETZA iscurrently 48 months from the date of tablet manufacture. On product launch in August 2006and through the second quarter of 2008, the shelf life of 500mg GLUMETZAproduct shipped by the Company was 36 months. 1000mg GLUMETZA tablets, whichbecame available in June 2008, currently have a shelf life of 24 monthsfrom the date of tablet manufacture. The Company estimates GLUMETZA productreturns based on an analysis of return rates of companies with products thathave similar characteristics and similar return policies within the metforminprescription market, trends in historical returns, shipments and prescriptionsand estimated channel inventory levels.

 

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

 

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

 

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

 

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

 

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

 

In April 2008, theCompany entered into a settlement and license agreement with TevaPharmaceuticals USA, Inc. (Teva) in which the Company is entitled toreceive royalties from Teva on sales by Teva or its affiliates of genericGlucophage®XR in the United States, subject to a $2.5 million aggregate royaltycap that was met in Q3 2009. The royalties were calculated as a percentage ofsales by Teva of generic Glucophage XR in the United States, as reported by athird-party market research company. The Company accrued royalties from Tevaeach quarter based on Teva’s sales of generic Glucophage XR reported by thethird-party market research company for that quarter. See Note 4 of the Notesto Condensed Financial Statements for further information on the settlement andlicense agreement.

 

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

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

·                  License andCollaborative Revenue - Revenue from license and collaborative arrangements isrecognized when 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 and collaborative fees arerecognized over the estimated performance period. License and collaborative feepayments received in excess of amounts earned are classified as deferredrevenue until earned.

 

***Recently Issued AccountingStandards***

* *

In August 2009, theFASB issued Accounting Standards Update No. 2009-05, *MeasuringLiabilities at Fair Value* (ASU 2009-05). ASU 2009-05 amendsAccounting Standards Codification Topic 820, *Fair ValueMeasurements*. Specifically, ASU 2009-05 provides clarification thatin circumstances in which a quoted price in an active market for the identicalliability is not available, a reporting entity is required to measure fairvalue using one or more of the following methods: 1) a valuation techniquethat uses a) the quoted price of the identical liability when traded as anasset or b) quoted prices for similar liabilities or similar liabilitieswhen traded as assets and/or 2) a valuation technique that is consistentwith the principles of Topic 820 of the Accounting Standards Codification. ASU2009-05 also clarifies that when estimating the fair value of a liability, areporting entity is not required to adjust to include inputs relating to theexistence of transfer restrictions on that liability. The adoption of thisstandard did not have a material impact on the Company’s financial statements.

 

In October 2009,the FASB issued ASU No. 2009-13, *Multiple-DeliverableRevenue Arrangements* (ASU 2009-13). ASU 2009-13 amends existingrevenue recognition accounting pronouncements that are currently within thescope of FASB Accounting Standards Codification Subtopic 605-25 (previouslyincluded within EITF 00-21, *Revenue Arrangements withMultiple Deliverables*(EITF 00-21)). The consensus to EITF Issue No. 08-01,*Revenue Arrangements with Multiple Deliverables*(EITF 08-01) provides accounting principles and application guidance onwhether multiple deliverables exist, how the arrangement should be separated,and the consideration allocated. This guidance eliminates the requirement toestablish the fair value of undelivered products and services and insteadprovides for separate revenue recognition based upon management’s estimate ofthe selling price for an undelivered item when there is no other means to determinethe fair value of that undelivered item. EITF 00-21 previously requiredthat the fair value of the undelivered item be the price of the item eithersold in a separate transaction between unrelated third parties or the pricecharged for each item when the item is sold separately by the vendor. This wasdifficult to determine when the product was not individually sold because ofits unique features. Under EITF 00-21, if the fair value of all of theelements in the arrangement was not determinable, then revenue was deferreduntil all of the items were delivered or fair value was determined. This newapproach is effective prospectively for revenue arrangements entered into ormaterially modified in fiscal years beginning on or after June 15, 2010.The Company is currently evaluating the potential impact of this standard onits financial position and results of operations.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

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

 

Securities classified asavailable-for-sale as of September 30, 2009 and December 31, 2008 aresummarized below (in thousands). Estimated fair value is based on quoted marketprices for these investments.

 
| **September 30, 2009**                                                  | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
| U.S. debt securities:                                                        |       |                |       |                         |       |                          |       |           |       |
| Total included in cash and  cash equivalents                                 |       | $                   | 9,863      |                         | $          | —                        |       | $              | —     |   | $ | 9,863 |   |
| Total maturing within 1  year and included in marketable securities:         |       |                |       |                         |       |                          |       |           |       |
| Commercial paper                                                             |       | 10,573              |       | 6                            |       | —                        |       | 10,579         |       |
| U.S. corporate debt  securities                                              |       | 16,648              |       | 37                           |       | (2                            | )          | 16,683         |       |
| U.S. government agency  debt securities                                      |       | 17,968              |       | 57                           |       | —                        |       | 18,025         |       |
| U.S. Treasury securities                                                     |       | 8,039               |       | 12                           |       | —                        |       | 8,051          |       |
| Total maturing between 1  and 2 years and included in marketable securities: |       |                |       |                         |       |                          |       |           |       |
| Commercial paper                                                             |       | —              |       | —                       |       | —                        |       | —         |       |
| U.S. corporate debt  securities                                              |       | 5,034               |       | 76                           |       | —                        |       | 5,110          |       |
| U.S. government agency  debt securities                                      |       | 12,560              |       | 1                            |       | (11                           | )          | 12,550         |       |
| U.S. Treasury securities                                                     |       | —              |       | —                       |       | —                        |       | —         |       |
| Total available-for-sale                                                     |       | $                   | 80,685     |                         | $          | 189                           |       | $              | (13        | ) | $ | 80,861 |   |

 
| **December 31,  2008**                                                  | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
| U.S. debt securities:                                                        |       |                |       |                         |       |                          |       |           |       |
| Total included in cash and  cash equivalents                                 |       | $                   | 20,155     |                         | $          | —                        |       | $              | —     |   | $ | 20,155 |   |
| Total maturing within 1  year and included in marketable securities:         |       |                |       |                         |       |                          |       |           |       |
| Commercial paper                                                             |       | 2,984               |       | 7                            |       | —                        |       | 2,991          |       |
| U.S. corporate debt  securities                                              |       | 7,648               |       | 5                            |       | (6                            | )          | 7,647          |       |
| U.S. government agency  debt securities                                      |       | 18,893              |       | 92                           |       | —                        |       | 18,985         |       |
| U.S. Treasury securities                                                     |       | 30,256              |       | 53                           |       | —                        |       | 30,309         |       |
| Total maturing between 1  and 2 years and included in marketable securities: |       |                |       |                         |       |                          |       |           |       |
| Commercial paper                                                             |       | —              |       | —                       |       | —                        |       | —         |       |
| U.S. corporate debt  securities                                              |       | —              |       | —                       |       | —                        |       | —         |       |
| U.S. government agency  debt securities                                      |       | —              |       | —                       |       | —                        |       | —         |       |
| U.S. Treasury securities                                                     |       | —              |       | —                       |       | —                        |       | —         |       |
| Total available-for-sale                                                     |       | $                   | 79,936     |                         | $          | 157                           |       | $              | (6         | ) | $ | 80,087 |   |

 

TheCompany considers all highly liquid investments with a maturity at date ofpurchase of three months or less to be cash equivalents. Cash and cashequivalents consist of cash on deposit with banks, money market instruments andcommercial paper. The Company places its cash, cash equivalents and marketablesecurities with high quality, U.S. financial institutions and, to date, has notexperienced material losses on any of its balances. All marketable securitiesare classified as available-for-sale since these instruments are readilymarketable. These securities are carried at fair value, which is based onreadily available market information, with unrealized gains and losses includedin accumulated other comprehensive loss within shareholders’ equity. TheCompany uses the specific identification method to determine the amount ofrealized gains or losses on sales of marketable securities. Realized gains orlosses have been insignificant and are included in “interest and other income”in the condensed statement of operations. As of September 30, 2009, theindividual contractual period for all available-for-sale debt securities isless than two years.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

At September 30,2009, the Company had five securities in an unrealized loss position. Thefollowing table shows the gross unrealized losses and fair value of the Company’sinvestments with unrealized losses that are not deemed to beother-than-temporarily impaired, aggregated by investment category and lengthof time that individual securities have been in a continuous unrealized lossposition, at September 30, 2009 (in thousands):

 
| ** **                              | ** ** | **Less than 12 months** | ** ** | **12 months or greater**      | ** ** | **Total**      | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-------------------------------|------------|----------------|------------|
| **U.S. Debt Securities**                | ** ** | **Fair Value**          | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| U.S. corporate debt securities          |       | $                       | 6,398      |                          | $          | (2             | )          | $ | — |   | $ | — |   | $ | 6,398 |   | $ | (2 | ) |
| U.S. government agency debt  securities |       | 9,049                   |       | (11                           | )          | —         |       | — |   | 9,049 |   | (11 | ) |
| Total available-for-sale                |       | $                       | 15,447     |                          | $          | (13            | )          | $ | — |   | $ | — |   | $ | 15,447 |   | $ | (13 | ) |

 

The gross unrealized losses above werecaused by interest rate increases. No significant facts or circumstances havearisen to indicate that there has been any deterioration in thecreditworthiness of the issuers of the Company’s securities. Based on theCompany’s review of these securities, including the assessment of the durationand severity of the unrealized losses and the Company’s ability and intent tohold the investments until maturity, there were no materialother-than-temporary impairments for these securities at September 30, 2009.

 

Fairvalue is defined as the exchange price that would be received for an asset or paidto transfer a liability (an exit price) in the principal or most advantageousmarket for the asset or liability in an orderly transaction between marketparticipants on the measurement date. Valuation techniques used to measure fairvalue must maximize the use of observable inputs and minimize the use ofunobservable inputs.

 

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

 

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

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

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

 

The following tablerepresents the Company’s fair value hierarchy for its financial assets measuredat fair value on a recurring basis as of September 30, 2009 (inthousands):

 
| ** **                             | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds                     |       | $           | 5,664      |        | $          | —      |       | $         | —     |   | $ | 5,664 |   |
| Commercial paper                       |       | —      |       | 14,778      |       | —      |       | 14,778    |       |
| U.S. corporate debt securities         |       | —      |       | 21,793      |       | —      |       | 21,793    |       |
| U.S. government agency debt securities |       | —      |       | 30,575      |       | —      |       | 30,575    |       |
| U.S. Treasury securities               |       | —      |       | 8,051       |       | —      |       | 8,051     |       |
| Total                                  |       | $           | 5,664      |        | $          | 75,197      |       | $         | —     |   | $ | 80,861 |   |

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

The following tablerepresents the Company’s fair value hierarchy for its financial assets measuredat fair value on a recurring basis as of December 31, 2008 (in thousands):

 
| ** **                             | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds                     |       | $           | 20,155     |        | $          | —      |       | $         | —     |   | $ | 20,155 |   |
| Commercial paper                       |       | —      |       | 2,991       |       | —      |       | 2,991     |       |
| U.S. corporate debt securities         |       | —      |       | 7,647       |       | —      |       | 7,647     |       |
| U.S. government agency debt securities |       | —      |       | 18,985      |       | —      |       | 18,985    |       |
| U.S. treasury securities               |       | —      |       | 30,309      |       | —      |       | 30,309    |       |
| Total                                  |       | $           | 20,155     |        | $          | 59,932      |       | $         | —     |   | $ | 80,087 |   |

 

There are no financialliabilities measured at fair value on a recurring basis as of September 30,2009 and December 31, 2008.

 

**NOTE3.  NET INCOME (LOSS) PER COMMON SHARE**

 

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

 
| ** **                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
|                               |       |                                      |       |                                     |       |   |   |   |   |
| Weighted-average shares -  basic   |       | 51,598,316                                |       | 48,123,668                               |       | 51,357,924 |   | 48,011,004 |   |
| Effect of dilutive  securities:    |       |                                      |       |                                     |       |   |   |   |   |
| Stock options                      |       | 861,168                                   |       | —                                   |       | — |   | — |   |
| Weighted-average shares -  diluted |       | 52,459,484                                |       | 48,123,668                               |       | 51,357,924 |   | 48,011,004 |   |

 

For the three and nine months ended September 30,2009, approximately 3.3 million and 6.1 million common stock equivalent sharesare not included because their effect is anti-dilutive. For the three and ninemonths ended September 30, 2008, approximately 8.5 million common stockequivalent shares are not included because their effect is anti-dilutive.

 

**NOTE 4. LICENSE AND COLLABORATIVEARRANGEMENTS**

 

***Merck &Co., Inc.***

 

In July 2009,the Company entered into a non-exclusive license agreement with Merck &Co., Inc. (Merck) granting Merck a license to certain patents related tothe Company’s metformin extended release technology to be used in developingfixed dose combinations of sitagliptin and extended release metformin.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

Under terms of theagreement, Merck received a non-exclusive license as well as other rights tocertain Depomed patents directed to metformin extended release technology.  In exchange, the Company received a $10.0million upfront fee in August 2009. The Company is also eligible toreceive a milestone payment upon filing of the New Drug Application for thetherapeutic candidate, as well as modest single digit royalties on any netproduct sales for an agreed-upon period. Merck will also be granted a right of reference to the New DrugApplication covering the Company’s GLUMETZA product in Merck’s regulatoryfilings covering fixed dose combinations of sitagliptin and extended releasemetformin. The Company has no development obligations under the agreement. TheCompany recognized the entire $10.0 million upfront payment as license revenuein the third quarter of 2009.

 

***Solvay Pharmaceuticals, Inc.***

 

In November 2008,the Company entered into an exclusive license agreement with SolvayPharmaceuticals, Inc. (Solvay) granting Solvay exclusive rights to developand commercialize DM-1796 for pain indications in the United States, Canada andMexico.  The agreement became effectivein January 2009, upon clearance of the transaction under Hart-Scott-RodinoAntitrust Improvements Act of 1976.

 

Pursuant to theagreement, Solvay Pharmaceuticals paid the Company a $25.0 million upfront feein February 2009. The Company is also eligible to receive milestonepayments for acceptance and FDA approval of the New Drug Application forDM-1796 for post-herpetic neuralgia (PHN), and sales milestone payments uponreaching certain sales milestones. Solvay will pay the Company royalties of 14to 20 percent of net product sales, depending on the level of product sales.

 

The Company wasresponsible for completion of the ongoing Phase 3 clinical trial for DM-1796 inPHN, which was completed in 2009, and will be responsible for certain otherregulatory support activities through NDA approval. Solvay will be responsiblefor the NDA filing and has the option to develop DM-1796 in further painindications other than PHN. If Solvay elects to develop DM-1796 in fibromyalgia,the Company has a right of first negotiation for co-promote rights in theobstetrics/gynecology field upon fibromyalgia indication regulatory approval.

 

The license agreementwill expire with the last to expire of the Company’s patents covering DM-1796,subject to early termination in certain circumstances.

 

The Company will beresponsible for the manufacture of DM-1796 for up to four years from theeffective date of the license agreement, pursuant to a supply agreement to beentered into by Depomed and Solvay.

 

The Company isrecognizing the $25.0 million upfront payment ratably over the period of theCompany’s development and supply obligations under the agreement which isestimated to be through January 2013. For the three and nine months ended September 30,2009, the Company recognized $1.6 million and $4.6 million, respectively, inlicense revenue under the arrangement. The remaining deferred revenue balanceis $20.4 million as of September 30, 2009.

 

Abbott Laboratories (Abbott) has agreed to acquire thepharmaceutical business of Solvay in a transaction expected to close in thefirst quarter of 2010.  Accordingly,following the closing of the transaction, Abbott will be responsible for theCompany’s DM-1796 license arrangement with Solvay, either directly or through asubsidiary.

 

***Covidien, Ltd.***

 

In November 2008, the Company entered into alicense agreement with Mallinckrodt, Inc., a subsidiary of Covidien, Ltd.(Covidien) granting Covidien worldwide rights to utilize the Company’s Acuform®technology for the exclusive development of four products containingacetaminophen in combination with opiates. In 2008, Covidien paid the Company atotal of $5.5 million in upfront fees, representing a $4.0 million upfrontlicense fee and a $1.5 million upfront payment for formulation work to beperformed by Depomed under the agreement. Under the agreement, the Company mayalso receive certain developmental milestone payments, if achieved, and is alsoentitled to receive royalties on sales of the products.

 

In October 2009, the first formulation wascompleted by the Company and delivered to Covidien, which triggered a $0.5million milestone payment from Covidien that was received by the Company in October 2009.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

The $5.5 million in upfront payments is beingaccounted for as a single unit of accounting and being amortized ratablythrough November 2011, which is the length of time Depomed is obligated toperform formulation work under the agreement. For the three and nine monthsended September 30, 2009, the Company recognized $0.5 million and $1.4million respectively in license revenue under the agreement. The remainingdeferred revenue balance is $3.9 million as of September 30, 2009.

 

***Santarus, Inc.***

 

In July 2008, the Company entered into a promotion agreement withSantarus, Inc. (Santarus) granting Santarus exclusive rights to promoteGLUMETZA in the United States. Santarus paid the Company a $12.0 millionupfront fee, and based on the achievement of specified levels of annualGLUMETZA net product sales, Santarus may be required to pay the Companyadditional one-time sales milestones totaling up to $16 million.

 

Santarus began promotion of GLUMETZA in October 2008.Santarus is required to meet certain minimum promotion obligations during theterm of the agreement, and is required to make certain minimum marketing,advertising, medical affairs and other commercial support expenditures. TheCompany continues to record revenue from the sales of GLUMETZA product, andstarting in October 2008, began paying Santarus a promotion fee equal to80% of the gross margin earned from net sales of GLUMETZA product in the UnitedStates. The promotion fee will be reduced to 75% of gross margin beginning inthe fourth quarter of 2010. For the three and nine months ended September 30,2009, the Company recognized $6.7 million and $16.9 million, respectively, inpromotion fee expense under the agreement, which is classified within selling,general and administrative expense.

 

Santarus is responsible for all costs associated with its sales forceand for all other marketing expenses associated with its promotion of GLUMETZAproduct. Depomed is responsible for overseeing product manufacturing andsupply. A joint commercialization committee has been formed to oversee andguide the strategic direction of the GLUMETZA alliance.

 

Pursuant to the terms of the promotion agreement, Depomed retains theoption to co-promote GLUMETZA product in the future to obstetricians andgynecologists. The promotion agreement will continue in effect until theexpiration of the last-to-expire patent or patent application with a validclaim in the territory covering a GLUMETZA product, unless terminated sooner.

 

The Company is recognizing the $12.0 million upfront payment ratablyuntil October 2021, which represents the estimated length of time theCompany’s obligations exist under the arrangement for promotion fees it isobligated to pay Santarus.  For the threeand nine months ended September 30, 2009, the Company recognized $0.2million and $0.7 million respectively in license revenue related to theamortization of the upfront payment. The remaining deferred revenue balance is$10.9 million as of September 30, 2009.

 

***WatsonPharma, Inc.***

 

In February 2009, the Company and Watson Pharma, Inc.(Watson) amended the promotion agreement between the parties, pursuant to whichWatson performed a specified number of physician details during the firstquarter of 2009, and will make an agreed upon number of sales calls in whichsamples of Proquin XR are delivered to physicians in each of the last three quartersof 2009.  The promotion agreement will terminate effective December 31,2009, or upon notice from the Company to Watson prior to that date.  TheCompany has no obligation to pay Watson promotion fees in 2009, or thereafter.

 

***Settlementwith TEVA Pharmaceuticals USA, Inc.***

 

In April 2008, the Company enteredinto a settlement and license agreement with Teva related to the patentinfringement lawsuit filed by the Company against Teva affiliates IVAXCorporation and IVAX Pharmaceuticals, Inc. The settlement agreementprovided for a one-time payment to the Company of $7.5 million, which theCompany received in April 2008, and for a non-exclusive license in favorof Teva (including IVAX) to continue to market its generic Glucophage XRproduct in the United States.  The $7.5million one-time payment received by the Company was recognized as a gain onlitigation settlement within operating income during the second quarter of2008.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

The Company also received ongoing royaltypayments from Teva on sales by Teva (including IVAX) of generic Glucophage XRin the United States, which was calculated as a percentage of sales, asreported by a third-party market research company.  The royalty wassubject to a $2.5 million aggregate cap, which was met during the third quarterof 2009.  For the three and nine monthsended September 30, 2009, the Company recognized $0.4 and $1.3 million inroyalty revenue related to this arrangement, respectively.  As of September 30, 2009, a cumulativetotal of $2.5 million in royalties has been recognized to date under thesettlement, with no royalties remaining under the aggregate cap.

 

**NOTE5.  LONG-TERM DEBT**

 

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

 

The Company paid interest only on the firsttranche for the first six months at an interest rate of 11.59%.  Beginning in January 2009, the Companybegan principal payments on the first tranche, plus interest at such rate,which will be paid in 30 equal monthly installments. The second tranche wasinterest-only through December 31, 2008, with principal and interestpayable thereafter in 30 equal monthly installments at an interest rate of11.59%. Interest expense, which includes amortization of debt issuance costs,was $0.2 million and $0.8 million for the three and nine months ended September 30,2009, respectively.

 

As of September 30, 2009, theoutstanding balance under the facility was $7.0 million, and the unamortizedportion of the debt issuance costs was $0.2 million. Future contractualprincipal and interest payments are as follows (in thousands):

 
| ** **                                                       | ** ** | **Principal** | ** ** | **Interest** | ** ** |
|------------------------------------------------------------------|------------|---------------|------------|--------------|------------|
| Less than 1 year (October 2009 –  September 2010) |       | $             | 3,734      |         | $          | 623 |   |
| 1-2 years (October 2010 – July 2011)              |       | 3,247         |       | 167          |       |
| Total                                                            |       | $             | 6,981      |         | $          | 790 |   |

 

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

 

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

 

The credit facility contains affirmativeand negative covenants with which the Company must comply with, and imposesrestrictions with regards to additional indebtedness, liens, variousfundamental changes (including mergers and acquisitions), payments,investments, transactions with affiliates, and other limitations customary insecured credit facilities. The Company was in compliance with such covenants asof September 30, 2009.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

**NOTE6.  STOCK-BASED COMPENSATION**

 

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

 
| ** **                                   | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                   | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                         |       |                                      |       |                                     |       |   |   |   |   |
| Cost of sales                                |       | $                                         | 4          |                                     | $          | 7 |   | $ | 20 |   | $ | 17 |   |
| Research and development  expense            |       | 267                                       |       | 171                                      |       | 703 |   | 552 |   |
| Selling, general and  administrative expense |       | 493                                       |       | 551                                      |       | 1,393 |   | 1,380 |   |
| Total                                        |       | $                                         | 764        |                                     | $          | 729 |   | $ | 2,116 |   | $ | 1,949 |   |

 

At September 30, 2009, the Company had $3.6million of total unrecognized compensation expense related to stock optiongrants that will be recognized over a weighted average period of 1.7 years.

 

**NOTE7.  COMPREHENSIVE INCOME (LOSS)**

 

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

 
| ** **                                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September  30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | **2009**                                  | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income (loss)                                        |       | $                                         | 1,373      |                                      | $          | (271 | ) | $ | (18,397 | ) | $ | (4,073 | ) |
| Unrealized gain (loss) on  available-for-sale securities |       | 54                                        |       | (252                                      | )          | 25 |   | (291 | ) |
| Total comprehensive income (loss)                        |       | $                                         | 1,427      |                                      | $          | (523 | ) | $ | (18,372 | ) | $ | (4,364 | ) |

 

**NOTE8.  INVENTORIES**

 

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

 
| ** **      | ** ** | **September 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|-----------------|------------|-----------------------------|------------|----------------------------|------------|
| Raw materials   |       | $                           | 130        |                       | $          | 266 |   |
| Work-in-process |       | —                      |       | 127                        |       |
| Finished goods  |       | 1,962                       |       | 2,392                      |       |
| Deferred costs  |       | 62                          |       | 64                         |       |
| Total           |       | $                           | 2,154      |                       | $          | 2,849 |   |

 

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

 

**NOTE9.  SHAREHOLDERS’ EQUITY**

 

***Option Exercises***

 

Forthe three and nine months ended September 30, 2009, employees andconsultants exercised options to purchase 398,833 and 415,167 shares of theCompany’s common stock with net proceeds to the Company of approximately $1.0million.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

***Employee Stock Purchase Plan***

 

In May 2009, the Company sold 134,555 shares under the ESPP. Theshares were purchased at a weighted average purchase price of $1.22 per sharewith proceeds of approximately $0.2 million.

 

**NOTE 10. RELATED PARTY TRANSACTIONS**

 

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

 

In August 2007, John W. Fara, Ph.D. retired from his positions asPresident, Chief Executive Officer and Chairman of the Company. Dr. Faracontinued to serve as a member of the Company’s Board of Directors until May 2008.The Company entered into a consulting agreement with Dr. Fara, pursuant towhich Dr. Fara will provide consulting services to the Company through December 31,2009. From August 2007 through December 31, 2008, the Company paid Dr. Fara$20,833 per month for his consulting services and reimbursed Dr. Fara forCOBRA and life insurance premiums. Dr. Fara will be paid on an hourlybasis for consulting services provided in 2009. For the three and nine monthsended September 30, 2009, the Company did not incur any expenses forconsulting services.

 

During the period of his consultancy, Dr. Fara will continue tovest in all of his currently unvested stock options, and his vested stockoptions will remain exercisable. For the three and nine months ended September 30,2009, the Company recognized approximately $8,000 and $20,000 in stockcompensation expense associated with these awards. In the event of a change incontrol of the Company, as defined by the Company’s 2004 Equity Incentive Plan,all of Dr. Fara’s unvested options will fully vest.

 

**NOTE 11.INCOME TAXES**

 

As of December 31, 2008and September 30, 2009, the Company had $2.8 million and $3.1 million ofunrecognized tax benefits, which is netted against deferred tax assets and isfully offset by a valuation allowance. All tax years since inception remain open to examination by the InternalRevenue Service and the California Franchise Tax Board until such time theCompany’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. The Company does not have anyaccrued interest or penalties associated with unrecognized tax benefits.  The Company does not foresee any materialchanges to unrecognized tax benefits within the next twelve months.

 

**NOTE 12.SUBSEQUENT EVENTS**

 

Weevaluated our subsequent events through November 6, 2009, when thefinancial statements were issued.

 

***Covidien***

 

In October 2009, the first formulation under theCompany’s agreement with Covidien was completed by the Company and delivered toCovidien, which triggered a $0.5 million milestone payment from Covidien to theCompany in October 2009. See Note 4 of the****Notesto Condensed Consolidated Financial Statements for further information aboutthe Company’s agreement with Covidien.

 

***Reduction in Force***

 

In October 2009, the Companyreduced its workforce by six employees, or approximately 7% of its full-timestaff to align its workforce with its anticipated staffing needs. The totalcost of the workforce reduction was approximately $0.4 million, whichconsists of cash payments for severance, medical insurance and outplacementservices and will be recognized as expense in the fourth quarter of 2009.

 

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

 

### **FORWARD-LOOKINGINFORMATION**

### ** **

Statements made in this “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and elsewhere in this QuarterlyReport on Form 10-Q that are not statements of historical fact areforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended (the Securities Act), and Section 21Eof the Securities Exchange Act of 1934, as amended.  We have based these forward-lookingstatements on our current expectations and projections about futureevents.  Our actual results could differmaterially from those discussed in, or implied by, these forward-lookingstatements. Forward-looking statements are identified by words such as “believe,”“anticipate,” “expect,” “intend,” “plan,” “will,” “may” and other similarexpressions.  In addition, any statementsthat refer to expectations, projections or other characterizations of futureevents or circumstances are forward-looking statements. Forward-lookingstatements include, but are not necessarily limited to, those relating to:

 

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

·                  thecommercial success and market acceptance of DM-1796 if it is approved formarketing in the United States, and the efforts of Solvay Pharmaceuticals, Inc.(Solvay) with respect to the commercialization of DM-1796;

·                  thestatus and additional development of SeradaTM for menopausal hot flashes;

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

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

·                  theresults of our internal research and development efforts;

·                  submission,acceptance and approval of regulatory filings;

·                  ourneed for, and ability to raise additional capital;

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

·                  ourplans to develop other product candidates.

 

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

 

**ABOUT DEPOMED**

 

Depomed is a specialtypharmaceutical company focused on the development and commercialization ofdifferentiated products that address large and growing markets and are based onproprietary oral drug delivery technologies. In 2009, we completed Phase 3 clinical trial for two productcandidates.  In October 2009, weannounced that DM-1796, an extended release formulation of gabapentin for thetreatment of postherpetic neuralgia that we have licensed to SolvayPharmaceuticals, Inc. met its primary endpoint with statisticalsignificance.  A New Drug Application(NDA) for DM-1796 is expected to be filed with the FDA in the first quarter of2010.  Also in October 2009, weannounced the results of Breeze 1 and Breeze 2, our Phase 3 clinical trials forSerada, our proprietary extended release formulation of gabapentin for thetreatment of menopausal hot flashes.  Thehigher dose formulation of Serada evaluated in the studies met five of eightco-primary endpoints across the two studies, while the lower dose formulationevaluated met four of eight co-primary endpoints.  We are continuing to analyze the data andintend to meet with the FDA to discuss the results of the studies and anyadditional clinical development that may be required to obtain approval tomarket Serada in the United States.

 

We seek to optimize theuse and value of our product candidates and drug delivery technologies in threeways.  First, we are seeking to assemblea number of pharmaceutical products that can be highly differentiated fromimmediate release versions of the compounds upon which they are based and maybe promoted together within a specialty pharmaceutical field, such as women’shealth care providers.  Our developmentof Serada, and our retention of co-promotion rights within theobstetrics/gynecology field in our commercialization arrangements withCovidien, Ltd. and Santarus, Inc., are examples of 

 

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this aspect of ourbusiness strategy.  Second, weout-license product candidates after we have increased their value through ourformulation and clinical development efforts. Our DM-1796 license and development arrangement with SolvayPharmaceuticals is an example of this strategy. Third, we enter into collaborative partnerships with other companieswhere the unique capabilities of our technology can provide superior value to apartner’s product candidate, resulting in greater value for Depomed thantraditional fee-for-service arrangements. Our license and development arrangement with Covidien, Ltd. and ourlicense agreement with Merck & Co., Inc. are examples of thisstrategy.

 

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

 

The following tablesummarizes our product pipeline and marketed products.

 

**Product Pipeline**

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

NDA  filing expected in Q1 2010

*Licensed  by Solvay in the United States, Mexico and Canada.* |
|----------|--------|----------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------|
|     |   |                             |   |                                                                                                                       |
| SeradaTM |   | Menopausal  hot flashes          |   | Phase  3 studies completed (Breeze 1 and Breeze 2). FDA meeting to discuss results  expected in December 2009.        |
|     |   |                             |   |                                                                                                                       |
| DM-3458  |   | Gastroesophageal  reflux disease |   | Proof  of concept studies completed.                                                                                       |
|     |   |                             |   |                                                                                                                       |
| DM-1992  |   | Parkinson’s  disease        |   | Phase  1 study completed.****Second Phase  1 study expected to be commenced in 2010.                                       |

 

**Marketed Products**

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

*Co-promoted  in the United States with Santarus.**Canadian  rights held by Biovail. Korean rights held by LG Life Sciences.* |
|                  |       |                                   |       |                                                                                                                                                                                   |
| Proquin® XR |       | Uncomplicated  urinary tract infection |       | Currently  sold in the United States.  Regulatory application approved in Sweden.*European rights held by Rottapharm/Madaus.*                                                          |

 

Our intellectual propertyposition includes thirteen issued patents and fifteen patent applicationspending in the United States.

 

***Significant Developments for the Quarter Ended September 30,2009.***

 

·                  In July 2009, we entered into anon-exclusive license agreement with Merck & Co., Inc. (Merck)granting Merck a license to certain patents related to the Company’s metforminextended release technology to be used in developing fixed dose combinations ofsitagliptin and extended release metformin.

 

·                  Revenue for the three months ended September 30,2009 was $23.0 million, compared to $14.1 million for the three months ended September 30,2008.  Revenue for the three months endedSeptember 30, 2009 included recognition of $10.0 million associated withour non-exclusive license agreement with Merck. Revenue for the three monthsended September 30, 2008 included the recognition of $6.3 million inpreviously deferred GLUMETZA product sales.

 

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·                  Operating expenses for the threemonths ended September 30, 2009 were $20.2 million, compared to $12.2million for the three months ended September 30, 2008.

 

·                  Cash, cash equivalents and marketablesecurities were $88.6 million as of September 30, 2009, compared to $82.1million as of December 31, 2008.

 

**RECENT PRODUCT DEVELOPMENTS AND TRANSACTIONS**

 

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

## * *

*Breeze1 and 2 Clinical Trials.*

 

*Study Design*.  We recently completed our Breeze 1 and 2clinical trials evaluating Serada in menopausal hot flashes.  Each trial was a Phase 3 randomized,double-blind, placebo-controlled studies of approximately 540 patients.  In September 2008, we enrolled and dosedthe first patient in Breeze 1, and in October 2008, we enrolled and dosed thefirst patient in Breeze 2.  In each study, patients were randomized intothree treatment arms:  (i) placebo; (ii) 1200mg of Serada dosed inthe evening; or (iii) a total dose of 1800mg of Serada dosed 600mg in themorning and 1200mg in the evening.  Wecompleted enrollment in Breeze 1 in February 2009, and completedenrollment in Breeze 2 in March 2009.

 

The treatment duration of the Breeze 1 study was sixmonths, with primary efficacy endpoints assessed at 4 and 12 weeks. Persistenceof efficacy were assessed at 6 months as one of the secondary endpoints. Thetreatment duration in the second study, Breeze 2, was three months, withassessment of efficacy at 4 and 12 weeks only.

 

The primary efficacy endpoints in both studies werereductions in the mean frequency of moderate to severe hot flashes, and theaverage severity of hot flashes. Various secondary efficacy endpoints weremeasured as well.

 

*Efficacy. *Asset forth in the table below, in the higher dose treatment arm of the two dosesevaluated, the 1800mg dose achieved positive results at 4 weeks. All fourco-primary endpoints of the 1800mg dose at 4 weeks demonstrated significantreductions in frequency and severity in both clinical trials.  Of the other four co-primary endpoints of the1800mg dose at 12 weeks, one endpoint was positive (p=0.0026) while the otherthree endpoints did not achieve statistical significance.

 

In the lower dose treatment arm, the 1200mg dose at 4weeks achieved statistical significance in three of the four co-primary endpoints.  Frequency was significantly reduced in bothclinical trials (p-values of 0.0024 and 0.0117) at four weeks. Severity wassignificantly reduced in only one trial (p-value 0.0016). Of the other fourco-primary endpoints of the 1200mg dose at 12 weeks, one endpoint was positive(p=0.0024) while the other three endpoints did not achieve statisticalsignificance.

 

Both patients’ and clinicians’ impression of overallimprovement in the higher dose treatment arm was highly statisticallysignificant relative to placebo in both studies.

 

The primary efficacy outcomes observed in the studiesare set forth in the tables below.

 

**Breeze 1**

 
| **Treatment** | ** ** | **Frequency (# per day)** | ** ** | **Severity (average per incident)** | ** ** |
|---------------|------------|---------------------------|------------|-------------------------------------|------------|
| **Group**     | ** ** | **Baseline**              | ** ** | **4 weeks**                    | ** ** | **12 weeks** | ** ** | **Baseline** | ** ** | **4 weeks** | ** ** | **12 weeks** | ** ** |
| 1800mg        |       | 11.1                      |       | 3.8 (p = 0.0001)                    |       | 3.7 (p = 0.02) |   | 2.5 |   | 1.8 (p = 0.0001) |   | 1.7 (p = 0.0468) |   |
| 1200mg        |       | 11.3                      |       | 4.5 (p = 0.0117)                    |       | 3.8 (p = 0.183) |   | 2.5 |   | 1.9 (p = 0.0016) |   | 1.7 (p = 0.0433) |   |
| placebo       |       | 11.3                      |       | 5.4                                 |       | 4.3 |   | 2.5 |   | 2.1 |   | 1.8 |   |

 

**Breeze 2**

 
| **Treatment** | ** ** | **Frequency (# per day)** | ** ** | **Severity (average per incident)** | ** ** |
|---------------|------------|---------------------------|------------|-------------------------------------|------------|
| **Group**     | ** ** | **Baseline**              | ** ** | **4 weeks**                    | ** ** | **12 weeks** | ** ** | **Baseline** | ** ** | **4 weeks** | ** ** | **12 weeks** | ** ** |
| 1800mg        |       | 11.2                      |       | 4.1 (p = 0.004)                     |       | 3.7 (p = 0.028) |   | 2.5 |   | 1.8 (p = 0.0003) |   | 1.6 (p = 0.0026) |   |
| 1200mg        |       | 12.0                      |       | 4.7 (p = 0.0024)                    |       | 3.9 (p = 0.0024) |   | 2.5 |   | 1.9 (p = 0.06) |   | 1.7 (p = 0.028) |   |
| placebo       |       | 11.2                      |       | 5.7                                 |       | 5.0 |   | 2.5 |   | 2.0 |   | 1.9 |   |

 

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*Safety. *Seradawas generally well tolerated in the study. The most common side effectsobserved in the study were headache, somnolence, dizziness and nausea.  The incidence of those side effects in eachof the treatment groups for each study are set forth in the tables below:

 

**Breeze 1**

 
| **Treatment Group** | ** ** | **Somnolence (%)** | ** ** | **Dizziness (%)** | ** ** | **Headache (%)** | ** ** | **Nausea (%)** | ** ** |
|---------------------|------------|--------------------|------------|-------------------|------------|------------------|------------|----------------|------------|
| 1800mg              |       | 19                 |       | 19                |       | 9                |       | 9              |       |
| 1200mg              |       | 13                 |       | 24                |       | 9                |       | 7              |       |
| placebo             |       | 3                  |       | 2                 |       | 6                |       | 4              |       |

 

**Breeze 2**

 
| **Treatment Group** | ** ** | **Somnolence (%)** | ** ** | **Dizziness (%)** | ** ** | **Headache (%)** | ** ** | **Nausea (%)** | ** ** |
|---------------------|------------|--------------------|------------|-------------------|------------|------------------|------------|----------------|------------|
| 1800mg              |       | 8                  |       | 19                |       | 7                |       | 7              |       |
| 1200mg              |       | 7                  |       | 17                |       | 5                |       | 3              |       |
| placebo             |       | 3                  |       | 3                 |       | 8                |       | 2              |       |

 

Withdrawals due to adverse events in each of thetreatment groups for each study are set forth in the tables below:

 

**Breeze 1**

 
| **Treatment Group** | ** ** | **Somnolence (%)** | ** ** | **Dizziness (%)** | ** ** |
|---------------------|------------|--------------------|------------|-------------------|------------|
| 1800mg              |       | 2                  |       | 1                 |       |
| 1200mg              |       | 3                  |       | 3                 |       |
| placebo             |       | 0                  |       | 0                 |       |

 

**Breeze 2**

 
| **Treatment Group** | ** ** | **Somnolence (%)** | ** ** | **Dizziness (%)** | ** ** |
|---------------------|------------|--------------------|------------|-------------------|------------|
| 1800mg              |       | 2                  |       | 3                 |       |
| 1200mg              |       | 0.5                |       | 3                 |       |
| placebo             |       | 0.5                |       | 0                 |       |

 

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

## * *

*Solvay Pharmaceuticals, Inc.*  In November 2008, we entered into anexclusive license agreement with Solvay Pharmaceuticals, Inc. grantingSolvay exclusive rights to develop and commercialize DM-1796 in the UnitedStates, Canada and Mexico for pain indications. The agreement became effectivein January 2009, upon clearance of the transaction under theHart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976.

 

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

 

We will remain responsible for completion of theongoing Phase 3 clinical trial for DM-1796 in PHN, and will be responsible forcertain other regulatory support activities through NDA approval.  Solvay will be responsible for NDA filing andhas the option to develop DM-1796 in further pain indications other thanPHN.  If Solvay elects to develop DM-1796in fibromyalgia, we have a right of first negotiation for co-promotion rightsin the obstetrics/gynecology field upon fibromyalgia indication regulatoryapproval.

 

We will be responsible for the manufacture of DM-1796for up to four years from the effective date of the License Agreement, pursuantto a supply agreement to be entered into by Depomed and Solvay by the end of2009. The License Agreement will expire with the last to expire of our patentscovering DM-1796, subject to early termination in certain circumstances.

 

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Abbott Laboratories (Abbott) has agreed to acquire thepharmaceutical business of Solvay in a transaction expected to close in thefirst quarter of 2010.  Accordingly,following the closing, Abbott will be responsible for our DM-1796 licensearrangement with Solvay, either directly or through a subsidiary.

 

*Phase 3Registration Program.*

 

*Study Design*.  In March 2008, we initiated dosing ofthe first patient in a Phase 3 clinical trial for DM-1796 for PHN.  The study was a randomized, double-blind,placebo-controlled study of approximately 450 PHN patients.  Patients in the study were randomized intotwo treatment arms:  placebo, or 1800mgof DM-1796 dosed once daily.  The studywas conducted at sites in the United States, Russia and Argentina. In June 2009,the study was fully enrolled.

 

The primary objective of the study is to assess theefficacy of DM-1796 in reducing the pain associated with PHN, measured from baselinepain scores to the end of a ten-week treatment period on the basis of theLikert pain scale.  Secondary objectives include an assessment of changesfrom baseline in sleep interference, and additional patient and clinicianassessments of pain and quality of life.

 

*Efficacy*.  DM-1796 demonstrated a statisticallysignificant reduction in pain associated with postherpetic neuralgia (PHN)versus placebo using the baseline observation carried forward (BOCF) methodrequired by FDA. The primary efficacy outcome observed in the study is setforth in the table below.

 

| **Treatment  Group** | ** ** | **Reduction in pain score at 10 weeks** |
|----------------------|------------|-----------------------------------------|
| 1800mg               |       | -2.1 (p = 0.0146)                       |
| placebo              |       | -1.6                                    |

 

*Safety.*  DM-1796 was generally well tolerated in thestudy.  The most common side effectsobserved in the study were somnolence and dizziness.  The incidence of those side effects in eachof the treatment groups for each study is set forth in the table below.

 
| **Treatment  Group** | ** ** | **Somnolence (%)** | ** ** | **Dizziness (%)** |
|----------------------|------------|--------------------|------------|-------------------|
| 1800mg               |       | 5                  |       | 11                |
| placebo              |       | 3                  |       | 2                 |

 

***DM-1992 for Parkinson’s Disease***

 

In July 2008, The Michael J. Fox Foundationawarded the Company a preclinical development grant to support the DM-1992program. DM-1992 is our investigative novel gastric retentive extended-releaseformulation of levodopa/carbidopa.

 

In January 2009, we initiated a Phase 1pharmacokinetic study in Parkinson’s patients designed to provide us withinsight into our formulation strategy for the DM-1992 program.  The Phase 1 trial in DM-1992 was arandomized, open-label crossover study that enrolled 18 patients with stableParkinson’s disease at two leading neurology centers in Russia.  The objective of the study was to compare thepharmacokinetics of two distinct formulations of DM-1992 and a generic versionof Sinemet CR sustained-release levodopa/carbidopa, as well as the safety andtolerability of the formulations. Patients in the trial received a single dose of each of the threetreatments being studied.  A dose of thefirst treatment was administered at the beginning of the study, followed by adose of a second treatment after 7 to 14 days, and a dose of the thirdtreatment after another 7 to 14 days. Blood samples were drawn during the 24 hour period followingadministration of each treatment. Patients remained on any anti-Parkinson’s therapy other thanlevodopa/carbidopa during the trial.

 

In August 2009, we completed the Phase 1study.  In the study, DM-1992 extendedcoverage above levodopa’s efficacious threshold and extended the time to peaklevodopa concentration relative to currently available sustained releaselevodopa/carbidopa formulations.  One ofour formulations tested in the study extended the median time at which levodopablood levels stayed above the efficacious threshold of 300 ng/mL toapproximately nine hours, compared to approximately seven hours for the genericversion of Sinemet CR tested in the study. The time to median peak levodopa blood levels in the study was extendedto four hours, compared to 2.8 hours for the comparator.

 

We anticipate commencing a second Phase 1 study in2010.

 

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***Merck &Co., Inc.***

 

In July 2009,we entered into a non-exclusive license agreement with Merck & Co., Inc.granting Merck a license to certain patents related to our metformin extendedrelease technology to be used in developing fixed dose combinations ofsitagliptin and extended release metformin.

 

Under terms of theagreement, Merck received a non-exclusive license as well as other rights tocertain of our patents directed to metformin extended release technology. Inexchange, we received a $10.0 million upfront fee in the third quarter of 2009.We are also eligible to receive a milestone payment upon filing of the New DrugApplication for the therapeutic candidate, as well as modest royalties on anynet product sales for an agreed-upon period. Merck will also be granted a right of reference to the New DrugApplication covering our GLUMETZA product in Merck’s regulatory filingscovering fixed dose combinations of sitagliptin and extended release metformin.We have no development obligations under the agreement.

 

***Proquin******®****** XR***

 

*Watson Pharma. *In February 2009, we amended ourpromotion agreement with Watson related to Proquin XR. Pursuant to the amendedagreement, Watson performed a specified number of details in the first quarterof 2009, and will make an agreed upon number of sales calls in which samples ofProquin XR are delivered to physicians in each of the last three quarters of2009. The agreement will terminate effective December 31, 2009, or uponnotice from us to Watson prior to that date. We have no obligation to payWatson promotion fees in 2009, and thereafter.

 

We are currently seeking to divest Proquin XR in theUnited States.

 

*Rottapharm/Madaus GmbH.*  In April 2009, we and Madaus GmbH, asuccessor in interest to Madaus S.r.l. and subsidiary of Rottapharm,(Rottapharm/Madaus) entered into an amended and restated license agreement forProquin XR in Europe, which amended the parties’ distribution and supplyagreement originally entered into in November 2005 and subsequentlyamended in November 2006. Under the amended and restated licenseagreement, we will no longer be obligated to supply commercial quantities ofProquin XR tablets in bulk form to Rottapharm/Madaus as contemplated under thedistribution and supply agreement, and we will now receive royalties on netsales of Proquin XR in Europe sold by Rottapharm/Madaus. We will be obligatedto provide regulatory and manufacturing support and consultation for up to anagreed upon number of hours per month through December 31, 2010 asreasonably requested by Rottapham/Madaus. The term of the amended and restatedlicense agreement is through July 2023.

 

In August 2008, Rottapharm/Madaus paid us an advance payment of$0.3 million intended for future product supply under the amended distributionand supply agreement. The $0.3 million advance payment will now be appliedtoward future royalties due to us under the amended and restated licenseagreement.

 

**CRITICAL ACCOUNTING POLICIES**

 

Criticalaccounting policies are those that require significant judgment and/orestimates by management at the time that the financial statements are preparedsuch that materially different results might have been reported if otherassumptions had been made. We consider certain accounting policies related torevenue recognition, accrued liabilities and stock-based compensation to becritical policies. There have been no changes to our critical accountingpolicies since we filed our 2008 Annual Report on Form 10-K with theSecurities and Exchange Commission on March 6, 2009. For a description ofour critical accounting policies, please refer to our 2008 Annual Report on Form 10-K.

 

### **RESULTS OF OPERATIONS**

### ** **

*Three and NineMonths Ended September 30, 2009 and 2008*

 

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### **Revenue**

### ** **

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

 
| ** **                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Product sales:                           |       |                                      |       |                                     |       |   |   |   |   |
| GLUMETZA                                 |       | $                                         | 9,771      |                                     | $          | 12,923 |   | $ | 24,659 |   | $ | 23,494 |   |
| Proquin XR                               |       | 88                                        |       | 88                                       |       | 448 |   | 262 |   |
| Total product sales                      |       | 9,859                                     |       | 13,011                                   |       | 25,107 |   | 23,756 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| Royalties:                               |       |                                      |       |                                     |       |   |   |   |   |
| GLUMETZA                                 |       | 67                                        |       | 100                                      |       | 168 |   | 283 |   |
| Teva                                     |       | 397                                       |       | 416                                      |       | 1,289 |   | 777 |   |
| Total royalties                          |       | 464                                       |       | 516                                      |       | 1,457 |   | 1,060 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| License and collaborative  revenue:      |       |                                      |       |                                     |       |   |   |   |   |
| Merck                                    |       | 10,000                                    |       | —                                   |       | 10,000 |   | — |   |
| DM-1796                                  |       | 1,561                                     |       | —                                   |       | 4,599 |   | — |   |
| GLUMETZA                                 |       | 626                                       |       | 584                                      |       | 1,878 |   | 1,311 |   |
| Acuform technology                       |       | 458                                       |       | —                                   |       | 1,374 |   | — |   |
| Proquin XR                               |       | 26                                        |       | —                                   |       | 59 |   | — |   |
| DM-1992                                  |       | 20                                        |       | —                                   |       | 20 |   | — |   |
| Total license and  collaborative revenue |       | 12,691                                    |       | 584                                      |       | 17,930 |   | 1,311 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| Total revenues                           |       | $                                         | 23,014     |                                     | $          | 14,111 |   | $ | 44,494 |   | $ | 26,127 |   |

 

***Productsales***

 

*GLUMETZA.*The decrease inGLUMETZA product sales in the three months ended September 30, 2009 ascompared to the three months ended September 30, 2008 is primarilyattributable to the recognition of $6.3 million in net product sales ofpreviously deferred GLUMETZA product sales during the three months ended September 30,2008. Beginning in the third quarter of2008, we began to recognize GLUMETZA product sales when title transfersto our customer, which is at the time our customer receives the productshipment, and we provide for an estimate of future product returns at thattime. This resulted in a one-time increase for the three and nine months ended September 30,2008 of $6.3 million in net product sales of GLUMETZA, representing productsales previously deferred, net of estimated product returns, managed care andMedicaid rebates, wholesaler and retail pharmacy fees and discounts,chargebacks and prompt payment discounts. Prior to the third quarter of 2008,we were unable to reasonably estimate expected returns of the product at thetime of shipment, and therefore, deferred revenue on product shipments untilthe product was dispensed through patient prescriptions. This decrease is offsetby increased demand and shipments of GLUMETZA resulting from Santarus’promotion efforts, as well as increased prices attributable to price increasesin 2009 for the three months ended September 30, 2009 as compared to thethree months ended September 30, 2008

 

The increase in GLUMETZA product sales for the ninemonths ended September 30, 2009 as compared to the nine months ended September 30,2008 is primarily attributable to increased demand and shipments of GLUMETZA,price increases of the 500mg GLUMETZA, and the introduction of the 1000mgGLUMETZA in June 2008.

 

Santarus began promotion of GLUMETZA in October 2008.From February 2008 through September 2008, we promoted GLUMETZAthrough a contract sales organization. Product sales for GLUMETZA relative toits current runrate will depend on the promotional success of Santarus.

 

*Proquin XR*.  We defer recognition of revenue on productshipments of Proquin XR until the right of return no longer exists, whichoccurs at the earlier of the time Proquin XR units are dispensed throughpatient prescriptions or expiration of the right of return. At September 30,2009, we have a deferred revenue balance, which is classified as a liability onthe balance sheet, of $1.6 million associated with the deferral of revenueon Proquin XR product shipments, which is net of estimated wholesaler fees,retail pharmacy discounts, stocking allowances and prompt payment discounts.

 

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The increase in Proquin XR product sales for the ninemonths ended September 30, 2009 as compared to the nine months ended September 30,2008 is primarily due to a longer period of time of promotion by Watson, whichbegan promotion in October 2007. In February 2009, we amended ourpromotion agreement with Watson, pursuant to which Watson performed a specifiednumber of details in the first quarter of 2009, and will make an agreed uponnumber of sales calls in which samples of Proquin XR are delivered tophysicians in each of the last three quarters of 2009.  The agreement will terminate effective December 31,2009, or upon notice from us to Watson prior to that date. Product sales forProquin XR relative to its current runrate may decrease as a result of adecrease in promotion efforts by Watson resulting from the amended promotionagreement. We are seeking to divest Proquin XR in the United States.

 

***Royalties***

 

*Teva*. In April 2008, we entered into a settlement and license agreementwith Teva related to the patent infringement lawsuit against Teva affiliatesIVAX Corporation and IVAX Pharmaceuticals, Inc. we initiated in January 2006related to Teva’s generic Glucophage XR tablets. In connection with thesettlement and license agreement we were entitled to receive up to a total of$2.5 million in future royalties on Teva’s generic Glucophage XR product in theUnited States. For the three and nine months ended September 30, 2009, werecognized $0.4 million and $1.3 million, respectively, in royalty revenuerelated to this arrangement. As of September 30, 2009, a cumulative totalof $2.5 million in royalties has been recognized to date, with no royaltiesremaining under the aggregate cap.

 

*GLUMETZA**.*GLUMETZA royalties relate to royalties we receivedfrom Biovail based on net sales of GLUMETZA in Canada and royalties we receivedfrom LG based on net sales of LG’s version of GLUMETZA, Novamet GR, in Korea.We began receiving royalties from Biovail in the first quarter of 2006 and fromLG in the first quarter of 2007. GLUMETZA royalties decreased for the ninemonths ended September 30, 2009 as compared to the nine months ended September 30,2008 primarily as a result of a temporary increase in the royalty rate on salesGLUMETZA in Canada for the royalty payment received from Biovail in the firstquarter of 2008, with the royalty rate returning back to its normal rate on FDAapproval of the 1000mg GLUMETZA in the United States in April 2008.

 

***Licenserevenue***

 

*Merck.* Merck license revenuefor the three and nine months ended September 30, 2009 relates to the$10.0 million upfront payment received from Merck in August 2009 under ournon-exclusive license agreement granting Merck a license to certain patentsrelated to the Company’s metformin extended release technology to be used indeveloping fixed dose combinations of sitagliptin and extended releasemetformin. As the Company has no continuing obligations under the agreement,the $10.0 million upfront payment was fully recognized as license revenue onreceipt in the third quarter of 2009 as we have no continuing obligations underthe agreement.

 

*DM-1796.*DM-1796 licenserevenue for the three and nine months ended September 30, 2009 relates tothe $25.0 million upfront payment received from Solvay under our licenseagreement granting Solvay exclusive rights to develop and commercialize DM-1796in the United States, Canada and Mexico for pain indications. We arerecognizing the $25.0 million upfront payment received from Solvay as revenueratably until January 2013, which represents the expected maximum lengthof time our development and supply obligations exist under the agreement.

 

*GLUMETZA.*GLUMETZA licenserevenue for the three and nine months ended September 30, 2009 consisted oflicense revenue recognized from the $25.0 million upfront license fee receivedfrom Biovail in July 2005 and the $12.0 million upfront fee received fromSantarus in July 2008.  Licenserevenue for the three and nine months ended September 30, 2008 consistedsolely of license revenue recognized from the $25.0 million upfront license feereceived from Biovail.

 

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

 

*Acuform Technology**.***In November 2008, we entered into alicense agreement with Covidien granting Covidien worldwide rights to utilizeour Acuform technology for the exclusive development of four productscontaining acetaminophen in combination with opiates. In 2008, Covidien paid usa total of $5.5 million in upfront fees, representing a $4.0 million upfrontlicense fee and a $1.5 million upfront payment for formulation work to beperformed by Depomed under the agreement. The entire $5.5 million is beingaccounted for as a single unit of accounting and being amortized ratablythrough November 2011, which is the length of time Depomed is obligated toperform formulation work under the agreement. In October 2009, the firstformulation was completed by us and delivered to Covidien, which triggered a$0.5 million milestone payment from Covidien to us in October 2009.

 

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**Cost of Sales**

 

Cost of sales consists of costs of the activepharmaceutical ingredient, contract manufacturing and packaging costs,inventory write-downs, product quality testing, internal employee costs relatedto the manufacturing process, distribution costs and shipping costs related toour product sales of GLUMETZA and Proquin XR. Total cost of sales for the threeand nine months ended September 30, 2009, as compared to the prior year,was as follows (in thousands):

 
| ** **    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **    | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost of sales |       | $                                         | 1,367      |                                     | $          | 2,396 |   | $ | 3,628 |   | $ | 4,567 |   |
|               |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

Cost of sales decreased in 2009 as compared to thecorresponding periods in 2008 primarily as a result of the recognition ofapproximately $1.0 million in GLUMETZA costs of sales associated withpreviously deferred revenue during the third quarter of 2008. In the thirdquarter of 2008, we began to recognize GLUMETZAproduct sales when title transfers to our customer, which is at the time ourcustomer receives the product shipment.

 

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

 

**Researchand Development Expense**

 

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

 

Totalresearch and development expense for the three and nine months ended September 30,2009, as compared to the prior year, was as follows (in thousands):

 
| ** **                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Research and development  expense  |       | $                                         | 9,300      |                                     | $          | 6,998 |   | $ | 29,345 |   | $ | 17,748 |   |
| Dollar change from prior  year     |       | 2,302                                     |       |                                     |       | 11,597 |   |   |   |
| Percentage change from  prior year |       | 32.9                                      | %          |                                     |       | 65.3 | % |   |   |
|                                    |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

The increase in research and development expense forthe three and nine months ended September 30, 2009 as compared to thethree and nine months ended September 30, 2008 was primarily due to higherclinical research organization expenses related to our two Phase 3 clinicaltrials for Serada for the treatment of menopausal hot flashes, which started inSeptember 2008. In February 2009, we completed enrollment of ourBreeze 1 Phase 3 clinical trial for Serada. In March 2009, we completedenrollment of our Breeze 2 Phase 3 clinical trial for Serada. The treatmentduration of the Breeze 1 study was six months, and the treatment duration ofthe Breeze 2 study was three months.  Thetrials were completed in October 2009.

 

In March 2008, we initiated dosing of the firstpatient in a Phase 3 clinical trial for DM-1796 for post-herpetic neuralgia.The treatment duration was ten weeks. In June 2009, we completedenrollment of our clinical trial for DM-1796 and the trial was completed in October 2009.

 

As the Phase 3 clinical trials were completed in October 2009,we expect research and development expense to decrease in the fourth quarter of2009.  We may have to conduct one or moreadditional Phase 3 trials associated with our Serada program in the future.

 

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

 
| ** **                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| **(In thousands)**                       | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Serada                                   |       | $                                         | 4,394      |                                     | $          | 2,319 |   | $ | 13,248 |   | $ | 4,559 |   |
| DM-1796                                  |       | 3,297                                     |       | 2,238                                    |       | 10,023 |   | 9,426 |   |
| Other projects                           |       | 1,609                                     |       | 2,441                                    |       | 6,074 |   | 3,763 |   |
| Total research and  development expenses |       | $                                         | 9,300      |                                     | $          | 6,998 |   | 29,345 |   | $ | 17,748 |   |
|                                          |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

**Selling, General and AdministrativeExpense**

 

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

 
| ** **                           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Selling, general and  administrative |       | $                                         | 10,931     |                                     | $          | 5,250 |   | $ | 29,878 |   | $ | 16,998 |   |
| Dollar change from prior  year       |       | 5,681                                     |       |                                     |       | 12,880 |   |   |   |
| Percentage change from  prior year   |       | 108.2                                     | %          |                                     |       | 75.8 | % |   |   |
|                                      |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

The increase in selling,general and administrative expense in 2009 as compared to 2008 was primarilydue to $6.7 million and $16.9 million in GLUMETZA promotion fee expense underour promotion agreement with Santarus for the three and nine months ended September 30,2009, respectively. Santarus began promotion of GLUMETZA in October 2008.

 

For the three monthsended September 30, 2009 compared to the three months ended September 30,2009, the increase in promotion fee expense was partially offset by decreasesin other sales and marketing expenses for GLUMETZA, as a majority of thoseefforts have been transferred to Santarus.

 

Our selling, general andadministrative expenses in future periods may increase if GLUMETZA gross marginincreases. GLUMETZA promotion fees payable to Santarus are calculated as apercentage of GLUMETZA gross margin. The promotion fee currently is 80% ofGLUMETZA gross margin and will be reduced to 75% of gross margin beginning inthe fourth quarter of 2010.

 

**Interest Income and Expense**

 
| ** **                     | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| **(in thousands)**             | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest and other income      |       | $                                         | 181        |                                     | $          | 515 |   | $ | 731 |   | $ | 1,871 |   |
| Interest expense               |       | (240                                      | )          | (249                                     | )          | (788 | ) | (254 | ) |
| Net interest income  (expense) |       | (59                                       | )          | 266                                      |       | (57 | ) | 1,617 |   |
|                                |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

Interest and other income decreased during the three and nine monthsended September 30, 2009 as compared to the corresponding period in 2008as a result of lower interest rates on our investments.

 

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

 

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**LIQUIDITYAND CAPITAL RESOURCES**

** **
| **(in thousands)**                                | ** ** | **September 30,********2009** | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------------------|------------|------------------------------------|------------|-----------------------------|------------|
| Cash, cash equivalents and  marketable securities |       | $                                  | 88,648     |                        | $          | 82,059 |   |
|                                                   |            |                                    |            |                             |            |  |  |

 

InAugust 2009, we received a $10.0 million upfront payment from Merckrelated to our non-exclusive license agreement with Merck. In February 2009,we received a $25.0 million upfront payment from Solvay related to our licenseagreement for DM-1796.

 

Sinceinception through September 30, 2009, we have financed our productdevelopment efforts and operations primarily from private and public sales ofequity securities and from license and termination fees from collaborative andlicense partners.

 

In December 2006, we entered into a common stockpurchase agreement with Azimuth Opportunity, Ltd., pursuant to which Azimuth iscommitted to purchase, from time to time and at our sole discretion, up to thelesser of (a) $30.0 million of our common stock, or (b) 8,399,654shares of common stock. In August 2008, the agreement was amended and theterm of the agreement was extended until December 2010. Sales to Azimuthunder the agreement, if any, will be made at a price equal to the averageclosing price of our common stock over a given pricing period, minus a discountranging from approximately 3.8% to 6.4%, which varies based on a thresholdprice set by us. Upon each sale of the our common stock to Azimuth under theagreement, we have also agreed to pay Reedland Capital Partners a placement feeequal to approximately 1.1% of the aggregate dollar amount of common stockpurchased by Azimuth. Azimuth is not required to purchase our common stock whenthe price of our common stock is below $2 per share. As of September 30,2009, we have not sold any common stock to Azimuth under this common stockpurchase agreement.

 

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

 

We paid interest only on the first tranchefor the first six months at an interest rate of 11.59%.  Thereafter we are required to pay principalon the first tranche, plus interest at such rate, in 30 equal monthlyinstallments. The second tranche was interest-only through December 31,2008, with principal and interest payable thereafter in 30 equal monthlyinstallments with an interest rate of 11.59%. As of September 30, 2009, the entireoutstanding balance on the credit facility was approximately $7.0 million at aninterest rate of 11.59%.

 

Our obligations under the loan agreement are secured by interests inall of our personal property, and proceeds from any intellectual property, butnot by our intellectual property.  Theloan agreement contains conditions precedent that must be satisfied prior toany borrowing and affirmative and negative covenants with which we mustcomply.  The loan agreement imposes restrictions with regards toadditional indebtedness, liens, various fundamental changes (including mergersand acquisitions), payments, investments, transactions with affiliates, andother limitations customary in secured credit facilities.  As of September 30, 2009, we were incompliance with such covenants. The loan agreement provides that events ofdefault will exist in certain circumstances, including failure to make paymentof principal or interest on the loans when required, failure to perform certainobligations under the loan agreement and related documents, defaults in certainother indebtedness and certain other events.  Upon an event of default,the principal amount of the loan may become due immediately.

 

Asof September 30, 2009, we have accumulated net losses of $168.6 million.We expect to continue to incur operating losses for the remainder of 2009. Weanticipate that our existing capital resources will permit us to meet ourcapital and operational requirements through at least the end of 2010. We basethis expectation on our current operating plan, which may change as aresult of many factors.

 

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

 

·          sales of our marketed products;

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

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

·          results of research and development efforts;

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

·          technological advances;

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

·          acquisitions or investment in complimentarybusinesses, products or technologies.

 

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

 

·          conduct research and development programs;

·          commercialize any products we market;

·          conduct preclinical and clinical testing; and

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

 

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

 

·          delay, postpone or terminate clinical trials;

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

·          obtain funds through entering intocollaboration agreements on unattractive terms.

 

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

 

### **Cash Flows from OperatingActivities**

### ** **

Cash provided by operating activities during the ninemonths ended September 30, 2009 was approximately $8.6 million, comparedto approximately $7.2 million for the nine months ended September 30,2008.  The increase in cash provided byoperating activities for the nine months ended September 30, 2009 ascompared to cash provided by operating activities for the nine months ended September 30,2008 was primarily due to an increase in deferred revenue as a result of thereceipt of the $25.0 million upfront payment from Solvay in February 2009offset by an increase in net loss for the nine months ended September 30,2009.

 

**Cash Flows from Investing Activities**

 

Net cash used in investing activities during the ninemonths ended September 30, 2009 was approximately $11.9 million andconsisted primarily of a net increase in marketable securities resulting frominvestment of the upfront payments received from Solvay ($25.0 million) andMerck ($10.0 million) in 2009. Net cash used in investing activities during thenine months ended September 30, 2008 was approximately $16.8 million andconsisted primarily of a net increase in marketable securities resulting fromthe investment of proceeds from our credit facility ($9.4 million) and Tevasettlement ($7.5 million) in 2008.

 

**Cash Flows from Financing Activities**

 

Cash used infinancing activities during the nine months ended September 30,2009 was approximately $1.2 million compared tocash provided by financing activities of approximately $9.4 million for thesame period in 2008. For the nine months ended September 30, 2009, cash used in financing activities primarily consistedof payments of principal on our credit facility offset by proceeds fromemployee and consultant option exercises. For the nine months ended September 30,2008, cash provided by financing activitiesprimarily consisted of proceeds from our credit facility.

 

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**Contractual Obligations**

 

As of September 30, 2009, our aggregate contractual obligationsare as shown in the following table (in thousands):

 
| ** **                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Total** | ** ** |
|----------------------------|------------|-----------------------|------------|---------------|------------|---------------|------------|-----------|------------|
| Operating leases           |       | $                     | 1,612      |          | $          | 2,176         |       | $         | —     |   | $ | 3,788 |   |
| Long-term debt (principal) |       | 3,734                 |       | 3,247         |       | —        |       | 6,981     |       |
| Long-term debt (interest)  |       | 623                   |       | 167           |       | —        |       | 790       |       |
| Purchase commitments       |       | 2,178                 |       | —        |       | —        |       | 2,178     |       |
|                       |       | $                     | 8,147      |          | $          | 5,590         |       | $         | —     |   | $ | 13,737 |   |

 

At September 30,2009, we had non-cancelable purchase orders and minimum purchase obligations ofapproximately $1.7 million under our manufacturing agreement with PatheonPuerto Rico, Inc. for the manufacture of the 500mg GLUMETZA and $0.5million under our supply agreement with Biovail for the supply of the 1000mgGLUMETZA. The amounts disclosed only represent minimum purchase requirements.Actual purchases are expected to exceed these amounts.

 

The contractualobligations reflected in this table exclude $3.0 million of contingentmilestone payments we may be obligated to pay in the future under oursublicense agreement with PharmaNova. These payments relate to variousmilestones for the product candidate under the sublicense agreement, includingsubmission to the FDA of an NDA and FDA approval of an NDA. The above tablealso excludes any future royalty payments we may be required to pay on productswe have licensed or any promotion fees associated with our promotion agreementwith Santarus.

 

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

 

There have been nosignificant changes in our market risk compared to the disclosures in Item 7Aof our Annual Report on Form 10-K for the year ended December 31,2008.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

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

 

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

 

***Changes in Internal Controls***

 

There were no changes inour internal controls over financial reporting during the quarter ended September 30,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II – OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

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

 

In December 2007, Apotex, Inc. (Apotex)filed the Canadian equivalent of an Abbreviated New Drug Application in Canadaseeking approval to market a generic version of the 500mg formulation ofGLUMETZA in Canada.  Apotex’s regulatoryfiling alleges that certain of the Canadian patents that we have licensed toBiovail in connection with Biovail’s commercialization of GLUMETZA in Canada are invalid and unenforceable, and thatApotex’s formulation does not infringe our patents.  Pursuant to the intellectual propertyenforcement provisions of our Canadian license agreement with Biovail forGLUMETZA, Biovail has the first right to prosecute, and pay for expensesrelated to, any Canadian litigation related to generic challenges toGLUMETZA.  In January 2008, Biovailfiled suit against Apotex in Canada in response to Apotex’s regulatory filing,and we have been joined to the lawsuit as a co-plaintiff with Biovail becausewe are the licensor of the patents at issue in the suit.  The initiation of the lawsuit automaticallystays approval of Apotex’s formulation for 24 months. In October 2008, thecourt issued a ruling requiring that Apotex present its evidence in the case bymid-January 2009, and that Biovail present its evidence by mid-April 2009. Eachparty has presented its evidence in the case. Depositions of witnesses andexperts in the case have occurred. A hearing before an administrative law judgeto determine the outcome of the matter is scheduled for November 2009. Anadverse outcome in this matter could substantially weaken our Canadian intellectualproperty.

 

**ITEM 1A.RISK FACTORS**

 

The risk factors presentedbelow amend and restate the risk factors previously disclosed in our AnnualReport on Form 10-K for the year ended December 31, 2008.

 

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

 

**Wedepend on Solvay Pharmaceuticals for certain aspects of the development andcommercialization of DM-1796, which subjects us to risks related to Solvay andits business that are outside our control.**

 

In January 2009, our exclusivelicense agreement with Solvay Pharmaceuticals Inc. related to the developmentandcommercialization of DM-1796 became effective. The license agreement grants Solvay exclusive rights to develop andcommercialize DM-1796 in the United States, Canada and Mexico for painindications.  We depend on Solvay toobtain regulatory approval and complete any further development of DM-1796, andto commercialize the product in the licensed territories, which subjects us toa number of risks, including the following:

 

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

 

·                  we and Solvay may not besuccessful in our efforts to obtain regulatory approval of DM-1796 in a timelymanner, or at all;

 

·                  Solvay may experience financialdifficulties; or

 

·                  Solvay may change its businessstrategy, due to a combination with another company or for another reasonunrelated to the DM-1796 commercial opportunity, in a manner that adverselyaffects the development or commercialization of DM-1796.

 

Abbott Laboratories hasagreed to acquire Solvay’s pharmaceutical business in a transaction expected toclose in the first quarter of 2010. Following the completion of the acquisition, Abbott will be responsiblefor the DM-1796 license arrangement, either directly or through asubsidiary.  We do not yet know whetherAbbott will be as committed to the development and commercialization of DM-1796as Solvay, and we are not likely to know until some time following thecompletion of the acquisition.  However,it is possible that Abbott’s acquisition of Solvay’s pharmaceutical businessmay adversely affect the development or commercialization of DM-1796.

 

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**Ourclinical trials evaluating S****erada****TM**** ****for menopausal hot flashes failed tomeet all of their primary endpoints.  Thestatus and future of our development of Serada for menopausal hot flashes isuncertain, and there can be no assurance this product will be approved formarketing.**

 

In October 2009, ourPhase 3 trials evaluating Serada for menopausal hot flashes failed to meet allof their primary endpoints.  We plan todiscuss with the FDA the results of the trials and any additional clinicaldevelopment that may be required to complete the program and obtain regulatoryapproval to market Serada in the United States. There can be no assurance the results of the Phase 3 trials we haveconducted, or any additional clinical trials we conduct, will demonstrate theproduct candidate is sufficiently safe and effective to obtain approval formarketing.

 

Clinical development is along, expensive and uncertain process and is subject to delays.  The positive or encouraging results of priorclinical trial are not necessarily indicative of the results we will obtain inlater clinical trials.  Accordingly, anyfuture clinical trials may not demonstrate that Serada is effective for menopausalhot flashes.  In addition, data obtainedfrom pivotal clinical trials are susceptible to varying interpretations, whichcould delay, limit or prevent regulatory approval. To obtain marketingapproval, we may decide, or the FDA or other regulatory authorities may requireus, to pursue additional pivotal clinical or other studies. These trials couldsignificantly delay the approval and commercialization of Serada for menopausalhot flashes and would require us to commit significant additional financial resources.Even after we conduct these additional clinical trials, we may not receiveregulatory approval to market the product.

 

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

 

·     negative orinconclusive results;

 

·     patient noncompliancewith the protocol;

 

·     adverse medicalevents or side effects among patients during the clinical trials;

 

·     FDA inspections ofour clinical operations; and

 

·     real or perceivedlack of effectiveness or safety of the product candidate.

 

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

 

In July 2008, we entered into a promotionagreement with Santarus, Inc. pursuant to which Santarus will promoteGLUMETZA in the United States through its sales force beginning in the fourthquarter of 2008. Under the agreement, in exchange for promotion fees, Santarusis required to market and promote GLUMETZA to physicians in the United States,to deliver annual detail calls to potential GLUMETZA prescribers, and tomaintain a sales force of a minimum size.  Although we have retainedrights to promote GLUMETZA to obstetricians/gynecologists, or ob/gyns, and toretain revenues from incremental sales generated by ob/gyns we call upon,ob/gyns generally do not prescribe significant amounts of metforminproducts.  In addition, we do not haveany immediate plans to establish a sales force, or contract with a third partyto act as our sales force, for the purpose of exercising our GLUMETZAco-promotion rights.  Accordingly, thesuccess of the commercialization of GLUMETZA will depend in large part onSantarus’ marketing and promotion efforts. Factors that may affect the success of our promotion arrangement withSantarus include the following:

 

·     Santarus may acquireor develop alternative products;

 

·     Santarus may pursuehigher-priority programs, or change the focus of its marketing programs;

 

·     Santarus may in thefuture choose to devote fewer resources to GLUMETZA;

 

·     GLUMETZA may fail toachieve greater market acceptance; and

 

·     Santarus may fail tocomply with its obligations under our promotion agreement.

 

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

 

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

 

We have the following programs in clinicaldevelopment: DM-1796 for neuropathic pain and Serada for menopausal hotflashes, and DM-1992 for Parkinson’s.  Wealso have other product candidates in earlier stages of development.

 

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

 

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

 

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

 

To date, we have recorded revenues from license fees,product sales, royalties, collaborative research and development arrangementsand feasibility studies.  For the ninemonths ended September 30, 2009, we recorded total revenues of $44.5million and for the years ended December 31, 2008, 2007 and 2006, werecorded total revenues of $34.8 million, $65.6 million, and $9.6 million,respectively. For the nine months ended September 30, 2009, we incurred anet loss of $18.4 million and for the years ended December 31, 2008 and2006 we incurred net losses of $15.3 million and $39.7 million, respectively.The termination of our license agreement with Esprit in July 2007,including the accelerated recognition of previously deferred revenue under thearrangement, and termination fees received associated with the termination ofour promotion agreement with King resulted in our reaching profitability in2007. Recognition of the entire $10.0 million upfront license payment wereceived from Merck resulted in our reaching profitability in the third quarterof 2009. However, as we continue our research and development efforts,preclinical testing and clinical trial activities, we anticipate that we willincur operating losses for the remainder of 2009.  Therefore, we expect our cumulative losses toincrease. These losses, among other things, have had, and we expect that theywill continue to have, an adverse impact on our total assets, shareholders’equity and working capital.

 

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

 

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

 

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

 

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

 

·                  the degree of commercial success of GLUMETZA;

 

·                  adverse events related to our products, including recalls;

 

·                  interruptions of manufacturing or supply;

 

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

 

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

 

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

 

·                  market acceptance of the Acuform technology;

 

·                  adoption of new technologies by us or our competitors;

 

·                  the introduction of new products by our competitors;

 

·                  manufacturing costs and difficulties;

 

·                  third-party reimbursement policies; and

 

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

 

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

 

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

 

We currently have collaboration arrangements withSolvay, Santarus and Covidien.  Inaddition, we have in the past and may in the future enter into othercollaborative arrangements, some of which have been based on less definitiveagreements, such as memoranda of understanding, material transfer agreements,options or feasibility agreements.  Wemay not execute definitive 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 enter into less favorable agreement terms that delay or defer recovery ofour development 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:

 

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

 

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

 

·                  premature termination of a collaborationagreement; or

 

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

 

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

 

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

 

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

 

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

 

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

 

We entered into a$15.0 million credit facility with Oxford Finance Corporation and GeneralElectric Capital Corporation in June 2008. We have drawn $9.4 million under the facility and will not make anyfurther draws under the facility. As of September 30, 2009, we have $7.0million of principal outstanding under the facility. The credit facility issecured by a pledge of all of our assets other than intellectual property, andcontains a variety of operational covenants, including limitations on ourability to incur liens or additional debt, make dispositions, pay dividends,redeem our stock, make certain investments and engage in certain merger,consolidation or asset sale transactions and transactions with affiliates,among other restrictions.  Any futuredebt financing we enter into may involve similar or more restrictive covenantsaffecting our operations.  Our borrowingsunder the credit facility or any future debt financing will need to be repaid,which creates additional financial risk for our company, particularly if ourbusiness, or prevailing financial market conditions, are not conducive topaying off or refinancing our outstanding debt obligations. Furthermore, ourfailure to comply with the covenants in the credit facility could result in anevent of default that, if not cured or waived, could result in the accelerationof all or a substantial portion of our debt, which could have a materialadverse effect on our cash position and significantly harm our business.

 

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

 

Our existing capitalresources may not be sufficient to fund our operations until such time as wemay be able to generatesufficient revenues to consistently support our operations.  We have limited credit facilities and, exceptfor our common stock purchase agreement with Azimuth, we have no othercommitted sources of capital.  Anyadditional development of Serada for menopausal hot flashes or other clinicaldevelopment programs may require considerable financial resources, should wechoose to invest in those programs. To the extent that our capital resourcesare insufficient to meet our future capital requirements, in order to continueour development programs, we will have to raise additional funds through thesale of our equity securities, through debt financing, or from development andlicensing arrangements. We may be unable to raise such additional capital onfavorable terms, or at all. If we raise additional capital by selling ourequity or convertible debt securities, the issuance of such securities couldresult in dilution of our shareholders’ equity positions. If adequate funds arenot available we may have to:

 

·                  delay, postpone or terminate clinical trials;

 

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

 

·                  obtain funds through entering into collaborationagreements on unattractive terms.

 

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

 

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

 

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

 

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

 

From time to time, we may become aware of activities by third partiesthat may infringe our patents.  Infringement by others of our patents mayreduce our market shares (if a related product is approved) and, consequently,our potential future revenues and adversely affect our patent rights if we donot take appropriate enforcement action.  We may need to engage inlitigation in the future to enforce any patents issued or licensed to us or todetermine the scope and validity of third-party proprietary rights.  Ourissued or licensed patents may not be held valid by a court of competentjurisdiction. Whether or not the outcome of litigation is favorable to us,defending a lawsuit takes significant time, may be expensive and may divertmanagement attention from other business concerns. We may also be required toparticipate in interference proceedings declared by the United States Patentand Trademark Office for the purpose of determining the priority of inventionsin connection with our patent applications or other parties’ patentapplications. Adverse determinations in litigation or interference proceedingscould require us to seek licenses which may not be available on commerciallyreasonable terms, or at all, or subject us to significant liabilities to thirdparties.  If we need but cannot obtain a license, we may be prevented frommarketing the affected product.

 

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

 

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

 

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orpharmacists could seek to fill prescriptions for Serada with anothermanufacturer’s gabapentin.  Although anysuch “off-label” use would violate our licensed patent, effectively monitoringcompliance with our licensed patent may be difficult and costly.

 

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

 

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

 

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

 

·                  obtain regulatory approval from the FDA or foreign regulatoryauthorities.

 

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

 

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

 

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

 

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

 

·                  market acceptance;

 

·                  cost-effective commercial scale production; and

 

·                  reimbursement under private or governmental health plans.

 

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

 

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

 

For planning purposes, wesometimes estimate the timing of the accomplishment of various scientific,clinical, regulatory and other product development and commercializationgoals.  These milestones may include ourexpectations regarding the commercial launch of our products by us or our licensees, and the commencement orcompletion of scientific studies and clinical trials and the submission orapproval of regulatory filings.  Fromtime to time, we may publicly announce the expected timing of some of thesemilestones, such as the completion of an ongoing clinical trial, the initiationof other clinical programs, or the commercial launch of products.  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:

 

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

 

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

 

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

 

·                  other actions by regulators;

 

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

 

·                  our available capital resources; and

 

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

 

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

 

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

 

We rely on clinicalinvestigators and clinical sites to enroll patients and other third parties tomanage our trials and to perform related data collection and analysis. However,we may be unable to control the amount and timing of resources that theclinical sites that conduct the clinical testing may devote to our clinicaltrials.  If our clinical investigatorsand clinical sites fail to enroll a sufficient number of patients in our clinicaltrials or fail to enroll them on our planned schedule, we will be unable tocomplete these trials or to complete them as planned, which could delay orprevent us from 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.

 

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

 

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

 

For example, the active ingredients in the products utilizingour Acuform delivery technology that are being developed pursuant to ourcollaboration with Covidien include acetaminophen in combination withopiates.  In connection with concernsthat consumers may inadvertently take more than the recommended daily dose ofacetaminophen, potentiallycausing liver damage, an FDA advisory committee has recommended thatprescription products containing acetaminophen in combination with prescriptionanalgesics (including opiates) should include black box warnings and/or beremoved from the market.  The FDA isevaluating the recommendations and has indicated that such an evaluation willtake some time.  The FDA is not requiredto accept advisory committee recommendations. Covidien’s ability or willingness to develop and market the productssubject to our collaboration may be adversely affected by actions of the FDA inresponse to the advisory committee recommendations.

 

Further, with respect to our approved products, onceregulatory approval is obtained, a marketed product and its manufacturer aresubject to continual review. The discovery of previously unknown problems witha product or manufacturer may result in restrictions on the product,manufacturer or manufacturing facility, including withdrawal of the product fromthe 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 GLUMETZA andProquin XR, as well as marketing activities related to any other products forwhich we obtain regulatory approval, will be subject to numerous federal andstate laws governing the marketing and promotion of pharmaceutical products.The FDA regulates post-approval promotional labeling and advertising to ensurethat they conform to statutory and regulatory requirements. In addition toFDA restrictions, the marketing of 

 

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prescription drugs is subject to laws and regulations prohibiting fraudand abuse under government healthcare programs. For example, the federalhealthcare program antikickback statute prohibits giving things of value toinduce the prescribing or purchase of products that are reimbursed by federalhealthcare programs, such as Medicare and Medicaid. In addition, federal falseclaims laws prohibit any person from knowingly presenting, or causing to bepresented, a false claim for payment to the federal government. Under this law,the federal government in recent years has brought claims against drugmanufacturers alleging that certain marketing activities caused false claimsfor prescription drugs to be submitted to federal programs. Many states havesimilar statutes or regulations, which apply to items and services reimbursedunder Medicaid and other state programs, or, in some states, regardless of thepayer. If we, or our collaborative partners, fail to comply with applicable FDAregulations or other laws or regulations relating to the marketing of ourproducts, we could be subject to criminal prosecution, civil penalties, seizureof products, injunction, and exclusion of our products from reimbursement undergovernment programs, as well as other regulatory actions against our productcandidates, our collaborative partners or us.

 

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

 

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

 

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

 

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

 

·                  government health administrationauthorities;

 

·                  private health insurers;

 

·                  health maintenance organizations;

 

·                  pharmacy benefit managementcompanies; and

 

·                  other healthcare-relatedorganizations.

 

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 competesuccessfully in the pharmaceutical product and drug delivery system industries.**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Ourbusiness involves exposure to potential product liability risks that areinherent in the development and production of pharmaceutical products. We haveobtained product liability insurance for clinical trials currently underway andforecasted 2009 sales of our products, but:

 

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

 

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

 

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

 

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

 

·                  our insurance may not provide adequate protection againstpotential liabilities.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

**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 Bayarea, which has a history of seismic activity. We have not established a formaldisaster recovery plan, and our back-up operations and our businessinterruption insurance may not be adequate to compensate us for losses thatoccur. A significant business interruption could result in losses or damages incurredby us and require us to cease or curtail our operations.

 

**ITEM 2.****          ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

Not applicable.

 

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

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM 5.           OTHERINFORMATION**

 

Not applicable.

 

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**ITEM 6. EXHIBITS**

 
| (a)    | Exhibits |                                                                                                               |
|--------|----------|--------------------------------------------------------------------------------------------------------------------|
|   | 31.1     | Certification  pursuant to Rule 13a-14(a) under the Securities Exchange Act of  1934 of Carl A. Pelzel   |
|   | 31.2     | Certification  pursuant to Rule 13a-14(a) under the Securities Exchange Act of  1934 of Tammy L. Cameron |
|   | 32.1     | Certification  pursuant to 18 U.S.C. Section 1350 of Carl A. Pelzel                                           |
|   | 32.2     | Certification  pursuant to 18 U.S.C. Section 1350 of Tammy L. Cameron                                         |

 

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##### **SIGNATURES**

##### ** **

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

 

 
| Date:  November 6, 2009 | DEPOMED, INC.       |
|------------------------------|--------------------------|
|                         |                     |
|                         |                     |
|                         | /s/ Carl A.  Pelzel      |
|                         | Carl A. Pelzel           |
|                         | President and            |
|                         | Chief Executive  Officer |
|                         |                     |
|                         |                     |
|                         | /s/ Tammy L.  Cameron    |
|                         | Tammy L. Cameron         |
|                         | Vice President,  Finance |

 

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