Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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

#### ** **

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

 

**FOR THE QUARTERLY PERIOD ENDED March 31, 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

 

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

 

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

 

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

 

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

 

The number ofissued and outstanding shares of the Registrant’s Common Stock, no par value,as of May 4, 2009 was 51,214,710.

 

 

 

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Table ofContents

 

**DEPOMED, INC.**

 
| ** **                                                                                              | **PAGE**   |
|---------------------------------------------------------------------------------------------------------|------------|
|                                                                                                    |       |
| **PART I — FINANCIAL INFORMATION**                                                            | ** ** |
|                                                                                                    |       |
| Item  1. Condensed Financial Statements:                                                                |       |
|                                                                                                    |       |
| Condensed Balance Sheets at March 31, 2009  (unaudited) and December 31, 2008                 | 3          |
|                                                                                                    |       |
| Condensed Statements of Operations for the three  months ended March 31, 2009 and 2008 (unaudited) | 4          |
|                                                                                                    |       |
| Condensed Statements of Cash Flows for the three  months ended March 31, 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     | 16         |
|                                                                                                    |       |
| Item 3. Quantitative and Qualitative Disclosure About  Market Risk                                      | 25         |
|                                                                                                    |       |
| Item 4. Controls and Procedures                                                                         | 25         |
|                                                                                                    |       |
| **PART II  — OTHER INFORMATION**                                                              | ** ** |
|                                                                                                    |       |
| Item  1. Legal Proceedings                                                                              | 27         |
|                                                                                                    |       |
| Item  1A. Risk Factors                                                                                  | 27         |
|                                                                                                    |       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                    | 39         |
|                                                                                                    |       |
| Item 3. Defaults upon Senior Securities                                                                 | 39         |
|                                                                                                    |       |
| Item 4. Submission of Matters to a Vote of Security  Holders                                            | 39         |
|                                                                                                    |       |
| Item  5. Other Information                                                                              | 39         |
|                                                                                                    |       |
| Item 6.  Exhibits                                                                                       | 40         |
|                                                                                                    |       |
| Signatures                                                                                              | 41         |

 

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**PART I— FINANCIAL INFORMATION**

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

###### ** **

**DEPOMED, INC.**

**CONDENSEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                              | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                                                              | ** ** | **(Unaudited)**    | ** ** | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                                                              | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                                                         |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                               |       | $                  | 9,588      |                  | $          | 22,127 |   |
| Marketable securities                                                                                                                                                                                                                   |       | 67,554             |       | 59,932                |       |
| Accounts receivable                                                                                                                                                                                                                     |       | 3,454              |       | 3,099                 |       |
| Unbilled accounts receivable                                                                                                                                                                                                            |       | 544                |       | 576                   |       |
| Inventories                                                                                                                                                                                                                             |       | 2,902              |       | 2,849                 |       |
| Prepaid and other current assets                                                                                                                                                                                                        |       | 3,471              |       | 5,404                 |       |
| Total current assets                                                                                                                                                                                                                    |       | 87,513             |       | 93,987                |       |
| Marketable securities                                                                                                                                                                                                                   |       | 16,997             |       | —                |       |
| Property and equipment, net                                                                                                                                                                                                             |       | 777                |       | 900                   |       |
| Other assets                                                                                                                                                                                                                            |       | 197                |       | 197                   |       |
|                                                                                                                                                                                                                                    |       | $                  | 105,484    |                  | $          | 95,084 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                                                                                          | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                                                                    |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                                        |       | $                  | 874        |                  | $          | 559 |   |
| Accrued compensation                                                                                                                                                                                                                    |       | 1,123              |       | 2,601                 |       |
| Accrued clinical trial expense                                                                                                                                                                                                          |       | 1,830              |       | 661                   |       |
| Other accrued liabilities                                                                                                                                                                                                               |       | 7,233              |       | 9,027                 |       |
| Deferred product sales                                                                                                                                                                                                                  |       | 1,645              |       | 1,702                 |       |
| Deferred license revenue                                                                                                                                                                                                                |       | 10,684             |       | 4,362                 |       |
| Other current liabilities                                                                                                                                                                                                               |       | 119                |       | 110                   |       |
| Current portion of long-term debt                                                                                                                                                                                                       |       | 3,423              |       | 3,356                 |       |
| Total current liabilities                                                                                                                                                                                                               |       | 26,931             |       | 22,378                |       |
| Deferred license revenue, non-current portion                                                                                                                                                                                           |       | 49,319             |       | 33,209                |       |
| Long-term debt, non-current portion                                                                                                                                                                                                     |       | 5,020              |       | 5,775                 |       |
| Other long-term liabilities                                                                                                                                                                                                             |       | 561                |       | 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 zero shares outstanding at March 31, 2009 and  December 31, 2008 |       | —             |       | —                |       |
| Common stock, no par value, 100,000,000 shares authorized; 51,214,710  and 51,171,377 shares issued and outstanding at March 31, 2009 and  December 31, 2008, respectively                                                    |       | 183,917            |       | 183,196               |       |
| Accumulated deficit                                                                                                                                                                                                                     |       | (160,349           | )          | (150,194              | )          |
| Accumulated other comprehensive gain                                                                                                                                                                                                    |       | 85                 |       | 151                   |       |
| Total shareholders’ equity                                                                                                                                                                                                         |       | 23,653             |       | 33,153                |       |
|                                                                                                                                                                                                                                    |       | $                  | 105,484    |                  | $          | 95,084 |   |

 

----

(1) Derived from the audited financial statements included in the Company’s Annual Report on Form 10-Kfor 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 March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                           | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Revenues:                                                                            |       |                                  |       |   |   |
| Product sales                                                                        |       | $                                     | 6,840      |   | $ | 5,226 |   |
| Royalties                                                                            |       | 464                                   |       | 112 |   |
| License revenue                                                                      |       | 2,568                                 |       | 363 |   |
| Total revenues                                                                       |       | 9,872                                 |       | 5,701 |   |
|                                                                                 |       |                                  |       |   |   |
| Costs and expenses:                                                                  |       |                                  |       |   |   |
| Cost of sales                                                                        |       | 1,032                                 |       | 1,209 |   |
| Research and development                                                             |       | 10,021                                |       | 6,069 |   |
| Selling, general and administrative                                                  |       | 9,002                                 |       | 6,507 |   |
| Total costs and expenses                                                             |       | 20,055                                |       | 13,785 |   |
|                                                                                 |       |                                  |       |   |   |
| Loss from operations                                                                 |       | (10,183                               | )          | (8,084 | ) |
|                                                                                 |       |                                  |       |   |   |
| Other income (expense):                                                              |       |                                  |       |   |   |
| Interest and other income                                                            |       | 314                                   |       | 803 |   |
| Interest expense                                                                     |       | (285                                  | )          | — |   |
| Total other income (expense)                                                         |       | 29                                    |       | 803 |   |
|                                                                                 |       |                                  |       |   |   |
| Net loss before income taxes                                                         |       | (10,154                               | )          | (7,281 | ) |
|                                                                                 |       |                                  |       |   |   |
| Provision for income taxes                                                           |       | 1                                     |       | — |   |
|                                                                                 |       |                                  |       |   |   |
| Net loss                                                                             |       | (10,155                               | )          | (7,281 | ) |
|                                                                                 |       |                                  |       |   |   |
| Deemed dividend on preferred stock                                                   |       | —                                |       | 175 |   |
|                                                                                 |       |                                  |       |   |   |
| Net loss applicable to common stock shareholders                                     |       | $                                     | (10,155    | ) | $ | (7,456 | ) |
|                                                                                 |       |                                  |       |   |   |
| Basic and diluted net loss applicable to common stock shareholders  per common share |       | $                                     | (0.20      | ) | $ | (0.16 | ) |
|                                                                                 |       |                                  |       |   |   |
| Shares used in computing basic and diluted net loss per common share                 |       | 51,207,540                            |       | 47,866,093 |   |

** **

See accompanying notes to Condensed Financial Statements.

 

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**DEPOMED, INC.**

**CONDENSED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **Operating Activities**                                                                   |       |                                  |       |   |   |
| Net loss                                                                                   |       | $                                     | (10,155    | ) | $ | (7,281 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in)  operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                              |       | 214                                   |       | 215 |   |
| Employee and director stock-based compensation                                             |       | 685                                   |       | 552 |   |
| Stock-based compensation related to consultants                                            |       | 9                                     |       | 69 |   |
| Changes in assets and liabilities:                                                         |       |                                  |       |   |   |
| Accounts receivable                                                                        |       | (323                                  | )          | 695 |   |
| Inventories                                                                                |       | (53                                   | )          | 1,057 |   |
| Prepaid and other current assets                                                           |       | 1,933                                 |       | (1,214 | ) |
| Accounts payable and other accrued liabilities                                             |       | (309                                  | )          | 116 |   |
| Accrued compensation                                                                       |       | (1,478                                | )          | (609 | ) |
| Deferred revenue                                                                           |       | 22,376                                |       | 530 |   |
| Net cash provided by (used in) operating activities                                        |       | 12,899                                |       | (5,870 | ) |
|                                                                                       |       |                                  |       |   |   |
| **Investing Activities**                                                                   |       |                                  |       |   |   |
| Purchases of property and equipment                                                        |       | (84                                   | )          | (46 | ) |
| Purchases of marketable securities                                                         |       | (63,523                               | )          | (22,202 | ) |
| Maturities of marketable securities                                                        |       | 32,847                                |       | 24,350 |   |
| Sales of marketable securities                                                             |       | 6,010                                 |       | 983 |   |
| Net cash (used in) provided by investing activities                                        |       | (24,750                               | )          | 3,085 |   |
|                                                                                       |       |                                  |       |   |   |
| **Financing Activities**                                                                   |       |                                  |       |   |   |
| Principal payments on long-term debt                                                       |       | (714                                  | )          | — |   |
| Proceeds from issuance of common stock                                                     |       | 26                                    |       | 3 |   |
| Net cash (used in) provided by financing activities                                        |       | (688                                  | )          | 3 |   |
|                                                                                       |       |                                  |       |   |   |
| Net decrease in cash and cash equivalents                                                  |       | (12,539                               | )          | (2,782 | ) |
| Cash and cash equivalents at beginning of period                                           |       | 22,127                                |       | 14,374 |   |
| Cash and cash equivalents at end of period                                                 |       | $                                     | 9,588      |   | $ | 11,592 |   |

 

See accompanying notes to Condensed Financial Statements.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

## ***Basis of Presentation***

## * *

These unauditedcondensed financial statements and the related footnote information of Depomed, Inc.(the Company or Depomed) have been prepared pursuant to the requirements of theSecurities and Exchange Commission (SEC) for interim reporting. As permittedunder those rules, certain footnotes or other financial information that arenormally required by U.S. generally accepted accounting principles have beencondensed or omitted pursuant to such rules and regulations. In theopinion of the Company’s management, the accompanying interim unauditedcondensed financial statements include all adjustments (consisting only ofnormal recurring adjustments) necessary for a fair presentation of theinformation for the periods presented. The results for the interim period endedMarch 31, 2009 are not necessarily indicative of results to be expectedfor the entire year ending December 31, 2009 or future operating periods.

 

The balance sheetas of December 31, 2008 has been derived from the audited financialstatements at that date. The balance sheet does not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements. For further information, refer tothe financial statements and footnotes thereto included in the Company’s annualreport on Form 10-K for the year ended December 31, 2008 filed withthe SEC.

 

***Use ofEstimates***

 

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe amounts reported in the financial statements and accompanying notes. Actualresults could differ from those estimates.

 

***Stock-Based Compensation***

* *

The Companycalculates stock-based compensation for all periods presented in accordancewith Statement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment* (FAS 123(R)), as interpreted by SECStaff Accounting Bulletin No. 107 (SAB 107), using the modifiedprospective transition method. FAS 123(R) is a revision of Statement ofFinancial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation*(FAS 123), and supersedes APB Opinion No. 25,*Accounting for Stock Issued to Employees*(APB No. 25).**FAS 123(R) requirescompanies to recognize the cost of employee and director services received inexchange for awards of equity instruments, based on the grant-date fair valueof those awards, in the statement of operations. Using the modified prospectivetransition method of FAS 123(R), Depomed began recognizing fair-valuecompensation expense for stock-based awards, including stock options grantedand purchase rights issued under its employee purchase plan after January 1,2006. The compensation expense for stock-based compensation is based on thesingle-option approach, includes an estimate for forfeitures and is recognizedover the vesting term of the options using the straight-line method. FAS 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. Depomedestimates forfeitures based on historical experience. See Note 6 of the Notesto Condensed Financial Statements for further information regarding Depomed’sstock-based compensation expense.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

***RevenueRecognition***

 

The Companyrecognizes revenue from the sale of its products, royalties earned, and onpayments received and services performed under contractual arrangements.Revenue arrangements with multiple elements are divided into separate units ofaccounting if certain criteria are met, including whether the delivered elementhas stand-alone value to the customer and whether there is objective andreliable evidence of the fair value of the undelivered items. The considerationreceived is allocated among the separate units based on their respective fairvalues, and the applicable revenue recognition criteria are applied to each ofthe separate units.

 

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

 

·                  Product Sales:

 

·                  *GLUMETZA**®*: The Companybegan selling GLUMETZA*®* (metformin hydrochloride extended releasetablets) in August 2006 to wholesalers and retail pharmacies that issubject to rights of return up to twelve months after product expiration.Beginning in the third quarter of 2008, the Company began recognizing revenuefor GLUMETZA sales at the time title transfers its customers, which occurs atthe time product is delivered to its customers. Prior to the third quarter of 2008, the Company was unable to reasonablyestimate expected returns of the product at the time of shipment, andtherefore, deferred revenue on product shipments of GLUMETZA until the productwas dispensed through patient prescriptions. The quantity of prescription unitsdispensed was estimated based on analysis of third-party information, includingthird-party market research data and information obtained from wholesalers withrespect to inventory levels and inventory movement. Based on the actualshipment trends, prescription trends and product returns history for GLUMETZAand based on an analysis of return rates of companies with products that havesimilar characteristics and similar return policies within the metforminprescription market, the Company concluded it had the information needed toreasonably estimate product returns beginning in the third quarter of 2008.

 

·                  *Proquin**®XR*: TheCompany sells Proquin® XR (ciprofloxacin hydrochloride extended releasetablets) to wholesalers and retail pharmacies that is subject to rights ofreturn up to twelve months after product expiration.  Given the Company’s limited history ofselling Proquin XR, the Company currently cannot reliably estimate expectedreturns of the product at the time of shipment. Accordingly, the Company defersrecognition of revenue on product shipments of Proquin XR until the right ofreturn no longer exists, which occurs at the earlier of the time Proquin XR unitsare dispensed through patient prescriptions or expiration of the right ofreturn. The Company estimates patient prescriptions dispensed using an analysisof third-party information, including third-party market research data andinformation obtained from wholesalers with respect to inventory levels andinventory movement. As a result of this policy, the Company has a deferredrevenue balance of $1.6 million at March 31, 2009 related to Proquin XRproduct shipments that have not been recognized as revenue, which is net ofwholesaler fees, retail pharmacy discounts and prompt payment discounts. TheCompany will recognize revenue upon the earlier to occur of prescription unitsdispensed or expiration of the right of return until it can reliably estimateproduct returns, at which time the Company will record a one-time increase innet revenue related to the recognition of revenue previously deferred. Inaddition, the costs of manufacturing Proquin XR associated with the deferredrevenue are recorded as deferred costs, which are included in inventory, untilsuch time the related deferred revenue is recognized.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

·                  ProductSales Allowances — The Company recognizes products 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, the Company may need to adjust these estimates, which could have aneffect on earnings in the period of adjustment. The Company’s product salesallowances 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 our product by the managed careorganization.

 

·                  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 is currently48 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 eligible low-income patients based on each individualstate’s guidelines regarding eligibility and services. Under the Medicaidrebate programs, the Company pays a rebate to each participating state,generally two to three months after the quarter in which the prescription isfilled. The Company estimates and accrues Medicaid rebates based on productpricing, current rebates and changes in the level of discounts the Companyoffers that may affect the level of Medicaid discount, historical and estimatedfuture percentages of our product sold to Medicaid recipients and estimatedlevels of inventory in the distribution channel.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

·                  Chargebacks —The Company provides discounts to authorized users of the Federal SupplySchedule (FSS) of the General Services Administration under an FSS contractnegotiated by the Department of Veterans Affairs.  These federal entities purchase products fromthe wholesale distributors at a discounted price, and the wholesaledistributors then charge back to the Company the difference between the currentretail price and the price the federal entity paid for the product.  The Company estimates and accrues chargebacksbased on estimated wholesaler inventory levels, current contract prices andhistorical chargeback activity.

 

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

 

InApril 2008, the Company entered into a settlement and license agreementwith Teva Pharmaceuticals USA, Inc. (Teva) in which the Company isentitled to receive royalties from Teva on sales by Teva or its affiliates ofgeneric Glucophage®XR in the United States, subject to a $2.5 million aggregatecap. The royalties are calculated as a percentage of sales by Teva of genericGlucophage XR in the United States, as reported by a third-party marketresearch company. The Company accrues royalties from Teva each quarter based onTeva’s sales of generic Glucophage XR reported by the third-party marketresearch company for that quarter. See Note 4 of the Notes to CondensedFinancial Statements for further information on the settlement and licenseagreement.

 

Royaltiesreceived under the Company’s agreements with Biovail Laboratories s.r.l.(Biovail) and LG Life Sciences (LG) are recognized when the royalty paymentsare received as they are not estimable.

 

·                  License Revenue - Revenue fromlicense arrangements is recognized when the Company has substantially completedits obligations under the terms of the arrangement and the Company’s remaininginvolvement is inconsequential and perfunctory. If the Company has significantcontinuing involvement under such an arrangement, license fees are recognizedover the estimated performance period. License fee payments received in excessof amounts earned are classified as deferred revenue until earned.

 

***Recently Issued AccountingStandards***

* *

In April 2009, the FASB issued Statement ofFinancial Position (FSP FAS) No. 157-4, *DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly*,and is effective for the Company beginning July 1, 2009.  FSP FAS 157-4 provides additional guidancefor estimating fair value in accordance with FASB Statement No. 157, *Fair Value Measurements*, when the volume and level ofactivity for the asset or liability have significantly decreases and includesguidance on identifying circumstances that indicate a transaction is notorderly. The Company does not expect the adoption of FSP FAS 157-4 to have amaterial effect on its financial statements.

 

In April 2009, the FASB issued Statement ofFinancial Position (FSP FAS) No. 115-2 and No. 124-2, *Recognition and Presentation of Other-Than-Temporary Impairments*,and is effective for the Company beginning July 1, 2009. FSP FAS 115-2 and124-2 amends the other-than-temporary impairment guidance in US GAAP for thedebt securities to make the guidance more operational and to improve thepresentation and disclosure of other-than-temporary impairments debt and equitysecurities. The Company does not expect the adoption of FSP FAS 115-2 and No124-2 to have a material effect on its financial statements.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

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

 

 The Companyconsiders all highly liquid investments with a maturity at date of purchase ofthree months or less to be cash equivalents. Cash and cash equivalents consistof cash on deposit with banks, money market instruments and commercial paper.The Company places its cash, cash equivalents and marketable securities withhigh quality, U.S. financial institutions and, to date, has not experiencedmaterial losses on any of its balances. The Company records cash equivalents atamortized cost, which approximates their fair value. 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 March 31, 2009, theindividual contractual period for all available-for-sale debt securities isless than two years.

 

Thefollowing table shows the gross unrealized losses and fair value of the Company’sinvestments with unrealized losses that are not deemed to be other-than-temporarilyimpaired, aggregated by investment category and length of time that individualsecurities have been in a continuous unrealized loss position, at March 31, 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** | ** ** |
| Commercial paper                       |       | $                       | 2,987      |                          | $          | (5             | )          | $ | — |   | $ | — |   | $ | 2,987 |   | $ | (5 | ) |
| U.S. corporate debt securities         |       | 10,319                  |       | (46                           | )          | —         |       | — |   | 10,319 |   | (46 | ) |
| U.S. government agency debt securities |       | —                  |       | —                        |       | —         |       | — |   | — |   | — |   |
| U.S. treasury securities               |       | —                  |       | —                        |       | —         |       | — |   | — |   | — |   |
| Total available-for-sale               |       | $                       | 13,306     |                          | $          | (51            | )          | $ | — |   | $ | — |   | $ | 13,306 |   | $ | (51 | ) |

 

Thegross unrealized losses above were caused by interest rate increases. No significantfacts or circumstances have arisen to indicate that there has been anydeterioration in the creditworthiness of the issuers of the Company’ssecurities. Based on the Company’s review of these securities, including theassessment of the duration and severity of the unrealized losses and theCompany’s ability and intent to hold the investments until maturity, there wereno material other-than-temporary impairments for these securities at March 31, 2009.

 

Effective January 1, 2008, the Companyadopted Statement of Financial Accounting Standards No. 157, Fair ValueMeasurements (FAS 157). FAS 157 defines fair value, establishes a framework formeasuring fair value under generally accepted accounting principles andenhances disclosures about fair value measurements. Fair value is defined underFAS 157 as the exchange price that would be received for an asset or paid totransfer 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 under FAS 157 must maximize the use of observable inputs and minimize theuse of unobservable inputs. The standard describes a fair value hierarchy basedon three levels of inputs, of which the first two are considered observable andthe last unobservable, that may be used to measure fair value which are thefollowing:

 

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

 

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

 

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

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

The adoption of FAS 157 did not have a material impacton the Company’s financial position, results of operations or cash flows. Inaccordance with FAS 157, the following table represents the Company’s fairvalue hierarchy for its financial assets measured at fair value on a recurringbasis as of March 31, 2009 (in thousands):

 
| ** **                             | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds                     |       | $           | 880        |        | $          | —      |       | $         | —     |   | $ | 880 |   |
| Commercial paper                       |       | —      |       | 12,674      |       | —      |       | 12,674    |       |
| U.S. corporate debt securities         |       | —      |       | 17,852      |       | —      |       | 17,852    |       |
| U.S. government agency debt securities |       | —      |       | 55,117      |       | —      |       | 55,117    |       |
| U.S. treasury securities               |       | —      |       | 3,904       |       | —      |       | 3,904     |       |
| Total                                  |       | $           | 880        |        | $          | 89,547      |       | $         | —     |   | $ | 90,427 |   |

 

The following table represents the Company’s fairvalue hierarchy for its financial assets measured at fair value on a recurringbasis 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 |   |

 

**NOTE 3.  NETLOSS PER COMMON SHARE**

 

Basic and dilutednet loss per common share is computed using the weighted-average number ofshares of common stock outstanding. Common stock equivalent shares, which arebased on the number of shares underlying outstanding stock options, warrantsand other convertible securities, are not included as their effect isantidilutive. At March 31, 2009 and 2008, the total number of outstandingcommon stock equivalents excluded from the loss per share computation were6,531,827 and 8,842,590, respectively.

 

**NOTE 4. LICENSE AND COLLABORATIVE ARRANGEMENTS**

 

***SolvayPharmaceuticals, Inc.***

 

In November 2008, the Company entered into anexclusive license agreement with Solvay Pharmaceuticals, Inc. (Solvay)granting Solvay exclusive rights to develop and commercialize DM-1796 for painindications in the United States, Canada and Mexico.  The agreement became effective in January 2009,upon clearance of the transaction under Hart-Scott-Rodino (HSR) AntitrustImprovements Act of 1976.

 

Pursuant to the agreement, Solvay Pharmaceuticals paidthe Company a $25.0 million upfront fee in February 2009. The Company isalso eligible to receive milestone payments for acceptance and FDA approval ofthe New Drug Application for DM-1796 for 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 will remain responsible for completion ofthe ongoing Phase 3 clinical trial for DM-1796 in PHN, and will be responsiblefor certain other regulatory support activities through NDA approval. Solvaywill be responsible for NDA filing and has the option to develop DM-1796 infurther pain indications other than PHN. If Solvay elects to develop DM-1796 infibromyalgia, the Company has a right of first negotiation for co-promoterights in the obstetrics/gynecology field upon fibromyalgia indicationregulatory approval.

 

The license agreement will expire with the last toexpire of the Company’s patents covering the Product, subject to earlytermination in certain circumstances.

 

The Company will be responsible for the manufacture ofDM-1796 for up to four years from the effective date of the license agreement,pursuant to a supply agreement to be entered into by Depomed and Solvay by July 2009.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

TheCompany is recognizing the $25.0 million upfront payment ratably over theperiod of the Company’s development and supply obligations under the agreementwhich is estimated to be through January 2013.  The Company recognized $1.5 million inlicense revenue under the arrangement for the quarter ended March 31,2009.  The remaining deferred revenuebalance is $23.5 million at March 31, 2009.

 

***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 our AcuForm®technology for the exclusive development of four undisclosed products. Through November 2008,Covidien paid the Company a total of $5.5 million in upfront fees, representinga $4.0 million upfront license fee and a $1.5 million upfront payment forformulation work to be performed by Depomed under the agreement. Under theagreement, the Company may also receive certain developmental milestonepayments, if achieved, and is also entitled to receive royalties on sales ofthe products.

 

The entire $5.5 million in upfront payments is being accounted for as asingle unit of accounting and being amortized ratably through November 2011,which is the length of time Depomed is obligated to perform formulation workunder the agreement. For the three months ended March 31, 2009, theCompany recognized $0.5 million in license revenue under the agreement.  The remaining deferred revenue balance is$4.8 million at March 31, 2009.

 

***Santarus, Inc.***

 

In July 2008, theCompany entered into a promotion agreement with Santarus, Inc. (Santarus)granting Santarus exclusive rights to promote GLUMETZA in the United States.Santarus paid the Company a $12.0 million upfront fee, and based on theachievement of specified levels of annual GLUMETZA net product sales, Santarusmay be required to pay the Company additional one-time sales milestones,totaling up to $16 million.

 

Santarus began promotionof GLUMETZA in October 2008. Santarus is required to meet certain minimumpromotion obligations during the term of the agreement, and required to makecertain minimum marketing, advertising, medical affairs and other commercialsupport expenditures. The Company continues to record revenue from the sales ofGLUMETZA product, and starting in October 2008, began paying Santarus apromotion fee ranging from 75% to 80% of the gross margin earned from net salesof GLUMETZA product in the United States. For the three months ended March 31,2009, the Company recognized $4.5 million in promotion fee expense under theagreement, which is classified within selling, general and administrativeexpense.

 

Santarus is responsiblefor all costs associated with its sales force and for all other marketingexpenses associated with its promotion of GLUMETZA product. Depomed isresponsible for overseeing product manufacturing and supply. A jointcommercialization committee has been formed to oversee and guide the strategicdirection of the GLUMETZA alliance.

 

Pursuant to the terms ofthe promotion agreement, Depomed retains the option to co-promote GLUMETZAproduct in the future to obstetricians and gynecologists. The promotionagreement will continue in effect until the expiration of the last-to-expirepatent or patent application with a valid claim in the territory covering aGLUMETZA product, unless terminated sooner.

 

The Company isrecognizing the $12.0 million upfront payment ratably until November 2021,which represents the estimated length of time the Company’s obligations existunder the arrangement for promotion fees it is obligated to pay Santarus.  For the three months ended March 31,2009, the Company recognized $0.2 million in license revenue related to theamortization of the upfront payment.  Theremaining deferred revenue balance is $11.4 million at March 31, 2009.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

***Watson Pharma, Inc.***

 

In February 2009,the Company and Watson Pharma, Inc. (Watson) amended the promotionagreement between the parties, pursuant to which Watson performed a specifiednumber of physician details during the first quarter of 2009, and will make anagreed upon number of sales calls in which samples of Proquin XR are deliveredto physicians in each of the last three quarters of 2009.  The promotionagreement will terminate effective December 31, 2009, or upon notice fromthe Company to Watson prior to that date.  The Company has no obligationto pay Watson promotion fees in 2009, and thereafter.

 

***Settlement with TEVA Pharmaceuticals USA, Inc.***

 

InApril 2008, the Company entered into a settlement and license agreementwith Teva related to the patent infringement lawsuit filed by the Companyagainst Teva affiliates IVAX Corporation and IVAX Pharmaceuticals, Inc.The settlement agreement provided for a one-time payment to the Company of $7.5million, which the Company received in April 2008, and for a non-exclusivelicense in favor of Teva (including IVAX) to continue to market its genericGlucophage XR product in the United States. The $7.5 million one-time payment received by the Company was recognizedas a gain on litigation settlement within operating income during the secondquarter of 2008.

 

TheCompany also receives ongoing royalty payments from Teva on sales by Teva(including IVAX) of generic Glucophage XR in the United States, which iscalculated as a percentage of sales, as reported by a third-party marketresearch company.  The royalty is subject to a $2.5 million aggregatecap.  For the quarter ended March 31,2009, the Company recognized $0.4 million in royalty revenue related to thisarrangement.  As of March 31, 2009,a cumulative total of $1.6 million in royalties has been recognized to date,with $0.9 million remaining under the aggregate cap.

 

**NOTE 5. LONG-TERM DEBT**

 

InJune 2008, the Company entered into a loan and security agreement withGeneral Electric Capital Corporation, as agent (GECC), and Oxford FinanceCorporation (Oxford) that provided the Company with a $15.0 million creditfacility. The credit facility was available in up to three tranches.  The first tranche of $3.8 million wasadvanced to the Company upon the closing of the loan agreement.  The second tranche of $5.6 million wasadvanced to the Company in July 2008. The third tranche of $5.6 millionwas not drawn and is no longer available to the Company, and GECC and Oxfordwaived the 2% unused line fee related to the unused portion of the creditfacility.

 

TheCompany paid interest on the first tranche for the first six months at aninterest rate of 11.59%.  Beginning in January 2009,the Company is required to pay the principal on the first tranche, plus interestat such rate, 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 $0.3 million for the three months ended March 31, 2009.

 

Asof March 31, 2009, the outstanding balance under the facility was $8.7million. Future contractual principal and interest payments are as follows (inthousands):

 
| ** **                                                | ** ** | **Principal** | ** ** | **Interest** | ** ** |
|-----------------------------------------------------------|------------|---------------|------------|--------------|------------|
| Less than 1 year (April 2009 — March 2010) |       | $             | 3,520      |         | $          | 837 |   |
| 1-2 years (April 2010 — March 2011)        |       | 3,957         |       | 400          |       |
| More than 2 years (April 2011 — July 2011) |       | 1,209         |       | 27           |       |
| Total                                                     |       | $             | 8,686      |         | $          | 1,264 |   |

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

TheCompany has the right to voluntarily prepay any tranches received under thefacility, in full or in part. Upon any voluntary prepayment of any of thetranches, the Company will be required to pay the lenders, a prepayment premiumequal to: (i) 5% on such prepayment amount, if such prepayment is madewithin 14 months after the closing date, (ii) 4% on such prepaymentamount, if such prepayment is made more than 14 months after the closing datebut within 29 months after the closing date, and (ii) 3% on suchprepayment amount, if such prepayment is made more than 29 months after theclosing date, but on or before the maturity date of the respective tranche.

 

Theobligations of the Company under the loan agreement are secured by interests inall of the Company’s personal property, and proceeds from any intellectualproperty, but not by the Company’s intellectual property.

 

Thecredit facility contains affirmative and negative covenants with which theCompany must comply with, and imposes restrictions with regards to additionalindebtedness, liens, various fundamental changes (including mergers andacquisitions), payments, investments, transactions with affiliates, and otherlimitations customary in secured credit facilities. The Company was incompliance with such covenants as of March 31, 2009.

 

**NOTE 6. STOCK-BASED COMPENSATION**

 

Thefollowing table presents stock-based compensation expense recognized under FAS123(R) for stock options, stock awards and the Company’s employee stockpurchase program (ESPP) in the Company’s statements of operations (inthousands):

 
| ** **                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|
| ** **                                  | ** ** | **2009**                              | ** ** | **2008** | ** ** |
|                                        |       |                                  |       |   |   |
| Cost of sales                               |       | $                                     | 9          |   | $ | 5 |   |
| Research and development expense            |       | 208                                   |       | 201 |   |
| Selling, general and administrative expense |       | 477                                   |       | 415 |   |
| Total                                       |       | $                                     | 694        |   | $ | 621 |   |

 

At March 31,2009, Depomed had $4.5 million of total unrecognized compensation expense, netof estimated forfeitures, related to stock option grants that will berecognized over an average vesting period of 2.1 years.

 

**NOTE 7. COMPREHENSIVE LOSS**

 

The following table summarizes components of totalcomprehensive loss (in thousands):

 
| ** **                                              | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                              | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Net loss                                                |       | $                                                    | (10,154    | ) | $ | (7,281 | ) |
| Unrealized (loss) gain on available-for-sale securities |       | (66                                                  | )          | 34 |   |
| Total comprehensive loss                                |       | $                                                    | (10,220    | ) | $ | (7,247 | ) |

 

**NOTE 8. INVENTORIES**

 

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

 
| ** **      | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|-----------------|------------|-------------------------|------------|----------------------------|------------|
| Raw materials   |       | $                       | 187        |                       | $          | 266 |   |
| Work-in-process |       | 414                     |       | 127                        |       |
| Finished goods  |       | 2,238                   |       | 2,392                      |       |
| Deferred costs  |       | 63                      |       | 64                         |       |
| Total           |       | $                       | 2,902      |                       | $          | 2,849 |   |

 

Deferredcosts represent the costs of Proquin XR product shipped for which recognitionof revenue has been deferred.

 

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**DEPOMED, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS (Continued)**

***(Unaudited)***

* *

**NOTE 9. SHAREHOLDERS’ EQUITY**

 

***OptionExercises***

 

During the three months ended March 31,2009, employees and consultants exercised options to purchase 13,333 shares ofthe Company’s common stock with net proceeds to the Company of approximately$26,000.

 

**NOTE 10.  RELATED PARTY TRANSACTIONS**

 

***JohnW. Fara, Ph.D.***

 

In August 2007, JohnW. Fara, Ph.D. retired from his positions as President, Chief Executive Officerand 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 months ended March 31,2009, the Company did not incur any expenses for consulting services.

 

During the period of hisconsultancy, Dr. Fara will continue to vest in all of his currentlyunvested stock options, and his vested stock options will remain exercisable.For the three months ended March 31, 2009, the Company recognized approximately$4,800 in stock compensation expense associated with these awards. In the eventof a change in control of the Company, as defined by the Company’s 2004 EquityIncentive Plan, all of Dr. Fara’s unvested options will fully vest.

 

**NOTE 11. INCOME TAXES**

 

As of December 31, 2008 and March 31,2009, the Company had $2.8 million and $2.9 million of unrecognized taxbenefits, which is netted against deferred tax assets and is fully offset by avaluation allowance.  All tax years sinceinception remain open to examination by the Internal Revenue Service and theCalifornia Franchise Tax Board until such time the Company’s net operatinglosses and credits are either utilized or expire. Interest and penalties, ifany, related to unrecognized tax benefits, would be recognized as income taxexpense by the Company. The Company does not have any accrued interest orpenalties associated with unrecognized tax benefits.  The Company does not foresee any materialchanges to unrecognized tax benefits within the next twelve months.

 

**NOTE 12. SUBSEQUENT EVENTS**

 

***Rottapharm/Madaus GmbH***

 

In April 2009, theCompany and Madaus GmbH, a successor in interest to Madaus S.r.l. andsubsidiary of Rottapharm, (Rottapharm/Madaus) entered into an amended andrestated license agreement for Proquin XR in Europe, which amended the parties’distribution and supply agreement originally entered into in November 2005and subsequently amended in November 2006. Under the amended and restatedlicense agreement, the Company will no longer be obligated to supply commercialquantities of Proquin XR tablets in bulk form to Rottapharm/Madaus ascontemplated under the distribution and supply agreement, and the Company willnow receive royalties on net sales of Proquin XR in Europe sold byRottapharm/Madaus. Depomed will be obligated to provide regulatory andmanufacturing support and consultation for up to an agreed upon number of hoursper month through December 31, 2010 as reasonably requested byRottapham/Madaus. The term of the amended and restated license agreement isthrough July 2023.

 

In August 2008,Rottapharm/Madaus paid the Company an advance payment of $0.3 million intendedfor future product supply under the amended distribution and supply agreement.The $0.3 million advance payment will now be applied toward future royaltiesdue to Depomed under the amended and restated license agreement.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

### **FORWARD-LOOKING INFORMATION**

### ** **

Statements made inthis “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” and elsewhere in this Quarterly Report on Form 10-Q thatare not statements of historical fact are forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended (theSecurities Act), and Section 21E of the Securities Exchange Act of 1934,as amended.  We have based theseforward-looking statements on our current expectations and projections aboutfuture events.  Our actual results coulddiffer materially 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:

 

·                  results and timingof our clinical trials, including the results of our DM-1796 and SeradaTMtrials;

 

·                  the commercialsuccess and market acceptance of Serada if we receive approval to market Seradain the United States;

 

·                  the commercialsuccess and market acceptance of DM-1796 if it is approved for marketing in theUnited States, and the efforts of Solvay Pharmaceuticals, Inc. (Solvay)with respect to the commercialization of DM-1796;

 

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

 

·                  the results ofour internal research and development efforts;

 

·                  acceptance andapproval of regulatory filings;

 

·                  our need for, andability to raise, additional capital;

 

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

 

·                  our plans todevelop other product candidates.

 

Factors that couldcause actual results or conditions to differ from those anticipated by theseand other forward-looking statements include those more fully described in the “**RISK FACTORS**” section and elsewhere in this QuarterlyReport on Form 10-Q. We disclaim any intent to update or revise these forward-lookingstatements to reflect new events or circumstances.

 

**ABOUT DEPOMED**

 

Depomed is a specialty pharmaceutical company focusedon the development and commercialization of differentiated products thataddress large and growing markets and are based on proprietary oral drugdelivery technologies.  We have twoproduct candidates in Phase 3 clinical trials. In March 2008, we initiateda Phase 3 clinical trial for DM-1796, an extended release formulation ofgabapentin for the treatment of postherpetic neuralgia that we have licensed toSolvay. In September and October 2008, we initiated Breeze 1 andBreeze 2, our Phase 3 clinical trials for Serada, an extended releaseformulation of gabapentin for the treatment of menopausal hot flashes.  In February 2009, we completedenrollment of our Breeze 1 trial, and in March 2009 we completedenrollment in our Breeze 2 trial for Serada. In 2009, we expect to completeenrollment of our DM-1796 Phase 3 clinical trial and expect to report top-lineresults for all three trials.

 

We seek to optimize the use and value of our productcandidates and drug delivery technologies in three ways.  First, we are seeking to assemble a number ofpharmaceutical products that can be highly differentiated from immediaterelease versions of the compounds upon which they are based and may be promotedtogether to women’s health care providers. Our development of Serada, and our retention of co-promotion rightswithin the obstetrics/gynecology field in our commercialization arrangementswith Covidien, Ltd. and Santarus, Inc., are examples of 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 than traditionalfee-for-service arrangements.  Ourlicense and development arrangement with Covidien, Ltd. is an example of thisstrategy.

 

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We developed two additional products which have beenapproved by the FDA and are currently marketed. GLUMETZA® (metforminhydrochloride extended release tablets) is a once-daily treatment for adultswith type 2 diabetes that we commercialize in the United States with Santarus, Inc.Proquin® XR (ciprofloxacin hydrochloride extended release tablets) is aonce-daily treatment for uncomplicated urinary tract infections that wecommercialize in the United States with Watson Pharma.

 

The following table summarizes our product pipelineand marketed products.

 

**ProductPipeline**

 
| SeradaTM                 |   | Menopausal hot flashes          |   | Phase 3 studies underway (Breeze 1 and Breeze 2).                                            |
|--------------------------|--------|---------------------------------|--------|----------------------------------------------------------------------------------------------|
|                     |   |                            |   |                                                                                         |
| DM-1796                  |   | Postherpetic neuralgia          |   | Second Phase 3 study underway.*Licensed by Solvay in the United States, Mexico  and Canada.* |
|                     |   |                            |   |                                                                                         |
| DM-3458                  |   | Gastroesophageal reflux disease |   | Proof of concept studies completed.                                                          |
|                     |   |                            |   |                                                                                         |
| DM-1992                  |   | Parkinson’s disease        |   | Phase 1 study underway.                                                                      |
|                     |   |                            |   |                                                                                         |
| One undisclosed compound |   | Confidential                    |   | Preclinical development ongoing.                                                             |

 

**MarketedProducts**

 
| **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. *Co-promoted in the United States with Watson  Pharma through December 31, 2009.*  Regulatory application approved in Sweden. *European rights held by Rottapharm/Madaus.* |

 

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

 

***Significant Developments for theQuarter Ended March 31, 2009.***

 

·                  InJanuary 2009, our license agreement with Solvay related to DM-1796 becameeffective after clearance of the transaction under the HSR AntitrustImprovements Act of 1976. Pursuant to the agreement, Solvay paid us a $25.0million upfront fee in February 2009.

 

·                  InFebruary 2009 and in March 2009, we completed enrollment of ourBreeze 1 and Breeze 2 Phase 3 clinical trials for Serada for the treatment ofmenopausal hot flashes.

 

·                  InFebruary 2009, we dosed the first patient in a Phase 1 clinical trial forour DM-1992 program in Parkinson’s disease.

 

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·                  In February 2009, we amended ourpromotion agreement with Watson, pursuant to which we are no longer obligatedto pay Watson promotion fees beginning in the first quarter of2009. Watson made a specified number of details in the first quarter of2009, 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 promotion agreement will terminate effective December 31,2009, or upon notice from us to Watson prior to that date.

 

·                  Revenuefor the three months ended March 31, 2009 was $9.9 million, compared to$5.7 million for the three months ended March 31, 2008.

 

·                  Operatingexpenses for the three months ended March 31, 2009 were $19.0 million,compared to $12.6 million for the three months ended March 31, 2008.

 

·                  Cash,cash equivalents and marketable securities were $94.1 million as of March 31,2009, compared to $82.1 million as of December 31, 2008.

 

**RECENT PRODUCT DEVELOPMENTS**

 

## ***SeradaTM***** forMenopausal Hot Flashes**

## * *

*Phase 3 Registration Program. *Our Phase 3 registration program for Serada in menopausal hot flashesincludes two randomized, double-blind, placebo-controlled studies ofapproximately 540 patients per study, Breeze 1 and Breeze 2. In September 2008,we enrolled and dosed the first patient in Breeze 1, and in October 2008,we enrolled and dosed the first patient in Breeze 2.  In each study,patients will be randomized into three treatment arms:  (i) placebo; (ii) 1200mgof Serada dosed once daily; or (iii) a total dose of 1800mg of Seradadosed 600mg in the morning and 1200mg in the evening.  We completed enrollment in Breeze 1 in February 2009,and completed enrollment in Breeze 2 in March 2009.

 

The treatment duration of the Breeze 1 study will besix months, with primary efficacy endpoints assessed at 4 and 12 weeks.Persistence of efficacy will be assessed at 6 months as one of the secondaryendpoints. The treatment duration in the second study, Breeze 2, will be threemonths, with assessment of efficacy at 4 and 12 weeks only.

 

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

 

We expect that preliminary top-line results of the studies will beavailable in the fourth quarter of 2009.

 

## ***DM-1796 forPostherpetic 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 paid us a $25 millionupfront fee in February 2009. We are also eligible to receive aggregatemilestone payments of up to $70 million for acceptance and FDA approval of the NewDrug Application for DM-1796 for PHN, and up to $300 million in potentialsales milestone payments. Solvay will pay us royalties of 14 to 20 percent ofnet product sales, depending on the level of net product sales.

 

We will remain responsible for completion of the ongoing Phase 3clinical trial for DM-1796 in PHN, and will be responsible for certain otherregulatory 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-1796 for up to fouryears from the effective date of the License Agreement, pursuant to a supplyagreement to be entered into by Depomed and Solvay by July 2009. TheLicense Agreement will expire with the last to expire of our patents coveringDM-1796, subject to early termination in certain circumstances.

 

*Phase 3 Registration Program. *In March 2008, we initiated dosing of the first patient in a secondPhase 3 clinical trial for DM-1796 for PHN. The study is a randomized, double-blind, placebo-controlled study ofapproximately 450 PHN patients.  Patientsin the study are randomized into two treatment arms:  placebo, or 1800mg of DM-1796 dosed oncedaily. The study is being conducted at sites in the United States, Russia andArgentina.

 

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

 

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

 

We expect thePhase 3 PHN study to be fully enrolled by the end of August 2009.  We expect preliminary top-line results from thestudy will be available in the fourth quarter of 2009.

 

***DM-1992for Parkinson’s Disease***

 

In July 2008, The Michael J. Fox Foundation awarded the Company apreclinical development grant to support the DM-1992 program. In January 2009,we commenced a Phase 1 study in Parkinson’s patients designed to provide uswith insight into our formulation strategy for our DM-1992 program.

 

***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 evaluating our options for the future of Proquin, whichinclude seeking to divest Proquin XR in the United 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 forfuture product supply under the amended distribution and supply agreement. The$0.3 million advance payment will now be applied toward future royalties due tous under the amended and restated license agreement.

 

**CRITICALACCOUNTING POLICIES**

 

Critical accountingpolicies are those that require significant judgment and/or estimates bymanagement at the time that the financial statements are prepared such thatmaterially different results might have been reported if other assumptions hadbeen made. We consider certain accounting policies related to revenuerecognition, accrued liabilities and stock-based compensation to be criticalpolicies. There have been no changes to our critical accounting policies sincewe filed our 2008 Annual Report on Form 10-K with the Securities andExchange Commission on March 6, 2009. For a description of our criticalaccounting policies, please refer to our 2008 Annual Report on Form 10-K.

 

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### **RESULTS OF OPERATIONS**

* *

*Three Months Ended March 31, 2009 and 2008*

* *

### **Revenue**

### ** **

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

 
| ** **              | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------|------------|---------------------------------------|------------|
| ** **              | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Product sales:          |       |                                  |       |   |   |
| GLUMETZA                |       | $                                     | 6,643      |   | $ | 5,166 |   |
| Proquin XR              |       | 197                                   |       | 60 |   |
| Total product sales     |       | 6,840                                 |       | 5,226 |   |
|                    |       |                                  |       |   |   |
| Royalties:              |       |                                  |       |   |   |
| GLUMETZA                |       | 36                                    |       | 112 |   |
| Teva                    |       | 428                                   |       | — |   |
| Total royalties         |       | 464                                   |       | 112 |   |
|                    |       |                                  |       |   |   |
| License revenue:        |       |                                  |       |   |   |
| DM-1796                 |       | 1,477                                 |       | — |   |
| GLUMETZA                |       | 626                                   |       | 363 |   |
| AcuForm technology |       | 458                                   |       | — |   |
| Proquin XR              |       | 7                                     |       | — |   |
| Total license revenue   |       | 2,568                                 |       | 363 |   |
|                    |       |                                  |       |   |   |
| Total revenues          |       | $                                     | 9,872      |   | $ | 5,701 |   |

 

***Product sales***

 

*GLUMETZA.*The increase in GLUMETZA product sales in the first quarter of 2009 ascompared to the first quarter of 2008 is primarily attributable to priceincreases of the 500mg GLUMETZA and the introduction of the 1000mg GLUMETZA in June 2008.

 

Beginning in the third quarter of 2008, webegan to recognize GLUMETZA product sales at time title transfers to ourcustomer, which is at the time our customer receives the product shipment, andprovide for an estimate of future product returns at that time. Prior to thethird quarter of 2008, we were unable to reasonably estimate expected returnsof the product at the time of shipment, and therefore, deferred revenue onproduct shipments until the product was dispensed through patientprescriptions.

 

Santarus beganpromotion of GLUMETZA in October 2008. From February 2008 through September 2008,we promoted GLUMETZA through a contract sales organization. Product sales forGLUMETZA relative to its current runrate will depend on the promotional successof Santarus.

 

*ProquinXR*.  We deferrecognition of revenue on product shipments of Proquin XR until the right ofreturn no longer exists, which occurs at the earlier of the time Proquin XRunits are dispensed through patient prescriptions or expiration of the right ofreturn. At March 31, 2009, we have a deferred revenue balance, which isclassified as a liability on the balance sheet, of $1.6 million associatedwith the deferral of revenue on Proquin XR product shipments, which is net ofestimated wholesaler fees, retail pharmacy discounts, stocking allowances andprompt payment discounts.

 

The increase in Proquin XR product sales in the first quarter of 2009as compared to the first quarter of 2008 is primarily due to a full year ofpromotion by Watson, which began promotion in October 2007. In February 2009,we amended our promotion agreement with Watson, pursuant to which Watson willperform a specified number of details in the first quarter of 2009, and willmake an agreed upon number of sales calls in which samples of Proquin XR aredelivered to physicians 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 currently evaluating our options for the future of Proquin,which include seeking to divest Proquin XR in the United States.

 

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***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 may receive up to a total of $2.5 millionin future royalties on Teva’s generic Glucophage XR product in the UnitedStates. For the three months ended March 31, 2009, we recognized $0.4million in royalty revenue related to this arrangement. As of March 31,2009, a cumulative total of $1.6 million in royalties has been recognized todate, with $0.9 million remaining 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 during the firstquarter of 2009 as compared to the first quarter of 2008 primarily as a resultof a temporary increase in the royalty rate on sales GLUMETZA in Canada for theroyalty payment received from Biovail in the first quarter of 2008, with theroyalty rate returning back to its normal rate on FDA approval of the 1000mgGLUMETZA in the United States.

 

***License revenue***

 

*DM-1796.*DM-1796 licenserevenue for the three months ended March 31, 2009 relates to the $25.0million upfront payment received from Solvay under our license agreementgranting Solvay exclusive rights to develop and commercialize DM-1796 in theUnited States, Canada and Mexico for pain indications. We are recognizing the$25.0 million upfront payment received from Solvay as revenue ratably until January 2013,which represents the expected maximum length of time our development and supplyobligations exist under the agreement.

 

*GLUMETZA.*GLUMETZA licenserevenue for the three months ended March 31, 2009 consisted of licenserevenue recognized from the $25.0 million upfront license fee received fromBiovail in July 2005 and the $12.0 million upfront fee received fromSantarus in July 2008.  Licenserevenue for the quarter ended March 31, 2008 consisted solely of licenserevenue recognized from the $25.0 million upfront license fee received fromBiovail.

 

We are recognizing the $25.0 million upfront license fee payment fromBiovail as revenue ratably until October 2021, which represents theestimated length of time our obligations exist under the arrangement related toroyalties we are obligated to pay Biovail on net sales of GLUMETZA in theUnited States and for our obligation to use Biovail as our sole supplier of the1000mg GLUMETZA. We are recognizing the $12.0 million upfront payment fromSantarus as revenue ratably until October 2021, which represents theestimated length of time our obligations exist under the arrangement related topromotion fees we are obligated to pay Santarus for GLUMETZA in the UnitedStates.

 

*AcuForm Technology.*In November 2008,we entered into a license agreement with Covidien granting Covidien worldwiderights to utilize our AcuForm technology for the exclusive development offour undisclosed products. Through November 2008, Covidien paid us a totalof $5.5 million in upfront fees, representing a $4.0 million upfront licensefee and a $1.5 million upfront payment for formulation work to be performed byDepomed under the agreement. The entire $5.5 million is being accounted for asa single unit of accounting and being amortized ratably through November 2011,which is the length of time Depomed is obligated to perform formulation workunder the agreement.

 

**Cost of Sales**

 

Cost of salesconsists of costs of the active pharmaceutical ingredient, contractmanufacturing and packaging costs, inventory write-downs, product qualitytesting, internal employee costs related to the manufacturing process,distribution costs and shipping costs related to our product sales. Total costof sales for the three months ended March 31, 2009, as compared to theprior year, was as follows (in thousands):

 
| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Cost of sales |       | $                                     | 1,032      |   | $ | 1,209 |   |
|               |            |                                       |            |  |  |  |  |

 

Cost of sales forthe three months ended March 31, 2009 and 2008 relates primarily to costsassociated with the sale of GLUMETZA and Proquin XR. Cost of sales decreasedslightly in three months ended March 31, 2009 as compared to the prioryear, primarily because the three months ended March 31, 2008 includedapproximately $0.3 million in inventory write-downs related to slow movingProquin XR inventory that we expected would not be sold prior to its expirationdate.

 

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The costs ofmanufacturing associated with deferred revenue on Proquin XR product shipmentsare recorded as deferred costs, which are included in inventory, until suchtime the related deferred revenue is recognized.

 

**Research and Development Expense**

 

Our research anddevelopment expenses currently include costs for scientific personnel,supplies, equipment, outsourced clinical and other research activities,consultants, depreciation, facilities and utilities. The scope and magnitude offuture research and development expenses cannot be predicted at this time forour product candidates in the early phases of research and development, as itis not possible to determine the nature, timing and extent of clinical trialsand studies, the FDA’s requirements for a particular drug and the requirementsand level of participation, if any, by potential partners. As potentialproducts proceed through the development process, each step is typically moreextensive, and therefore more expensive, than the previous step. Success indevelopment therefore, generally results in increasing expenditures untilactual product launch.

 

Total research anddevelopment expense for the three months ended March 31, 2009, as comparedto the prior year, was as follows (in thousands):

 
| ** **                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Research and development expense  |       | $                                     | 10,021     |   | $ | 6,069 |   |
| Dollar change from prior year     |       | 3,952                                 |       |   |   |
| Percentage change from prior year |       | 65.1                                  | %          |   |   |
|                                   |            |                                       |            |  |  |  |  |

 

The increase inresearch and development expense for the three months ended March 31, 2009as compared to the three months ended March 31, 2008 was primarily due tohigher clinical research organization expenses related to our two Phase 3clinical trials for Serada for the treatment of menopausal hot flashes, whichstarted in September 2008. In February 2009, we completed enrollmentof our Breeze 1 Phase 3 clinical trial for Serada and in March 2009, wecompleted enrollment of our Breeze 2 Phase 3 clinical trial for Serada. Thetreatment duration of the Breeze 1 study is six months, and the treatmentduration of the Breeze 2 study is three months.

 

In March 2008,we initiated dosing of the first patient in a Phase 3 clinical trial forDM-1796 for post-herpetic neuralgia. The treatment duration is ten weeks, andwe expect the Phase 3 clinical trial to be fully enrolled by the end of August 2009.

 

Because of thesethree ongoing Phase 3 clinical trials, we expect research and developmentexpense to remain flat or slightly increase from its current runrate for atleast the next two quarters of 2009.

 

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

 
| ** **                              | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                              | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| DM-1796                                 |       | $                                     | 4,081      |   | $ | 3,966 |   |
| Serada                                  |       | 3,575                                 |       | 1,416 |   |
| Other projects                          |       | 2,365                                 |       | 687 |   |
| Total research and development expenses |       | $                                     | 10,021     |   | $ | 6,069 |   |

 

**Selling,General and Administrative Expense**

 

Selling, general andadministrative expenses primarily consist of personnel expenses to support ouroperating activities, marketing and promotion expenses associated with GLUMETZAand Proquin XR, facility costs and professional expenses, such as legal andaccounting fees. Total selling, general and administrative expenses, ascompared to the prior year, were as follows (in thousands):

 
| ** **                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|
| ** **                          | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Selling, general and administrative |       | $                                     | 9,002      |   | $ | 6,507 |   |
| Dollar change from prior year       |       | 2,495                                 |       |   |   |
| Percentage change from prior year   |       | 38.3                                  | %          |   |   |
|                                     |            |                                       |            |  |  |  |  |

 

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The increase in selling, general andadministrative expense for the three March 31, 2009 as compared to thethree months ended March 31, 2008 was primarily due to $4.5 million inGLUMETZA promotion fee expense under our promotion agreement with Santarus, whobegan promotion of GLUMETZA in October 2008, which is partially offset bydecreases in other sales and marketing expenses for GLUMETZA for the threemonths ended March 31, 2009, as the majority of those efforts have beentransferred to Santarus, as well as a decrease in legal expenses in the threemonths ended March 31, 2009 resulting from our litigation settlement withIVAX in April 2008.

 

**InterestIncome and Expense**

 
| ** **                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|
| **(in thousands)**            | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Interest and other income     |       | $                                     | 314        |   | $ | 803 |   |
| Interest expense              |       | (285                                  | )          | — |   |
| Net interest income (expense) |       | 29                                    |       | 803 |   |
|                               |            |                                       |            |  |  |  |  |

 

Interest and other incomedecrease during the three months March 31, 2009 as compared to thecorresponding period in 2008 as a result of lower interest rates on ourinvestments.

 

Interest expense relatesto interest on the credit facility we entered into in June 2008 withGeneral Electric Capital Corporation and Oxford Finance Corporation.

 

**LIQUIDITY AND CAPITAL RESOURCES**

** **
| **(in thousands)**                               | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Cash, cash equivalents and marketable securities |       | $                        | 94,139     |                        | $          | 82,059 |   |
|                                                  |            |                          |            |                             |            |  |  |

 

In February 2009, we received a $25.0million upfront payment from Solvay related to our license agreement forDM-1796.

 

Since inception through March 31, 2009, wehave financed our product development efforts and operations primarily fromprivate and public sales of equity securities and from license and terminationfees from collaborative and license 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 March 31, 2009,we have not sold any common stock to Azimuth under this common stock purchaseagreement.

 

In June 2008, we entered into a creditfacility with GECC and Oxford. The credit facility was available in up to threetranches.  The first tranche of $3.8million was advanced 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.

 

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Wepaid interest only on the first tranche for the first six months at an interestrate of 11.59%.  Thereafter we arerequired to pay principal on the first tranche, plus interest at such rate, in30 equal monthly installments. The second tranche was interest-only through December 31,2008, with principal and interest payable thereafter in 30 equal monthlyinstallments and has an interest rate of 11.59%. As of March 31, 2009, the outstandingbalance on the credit facility was $8.7 million at an interest rate of 11.59%.

 

Our obligationsunder the loan agreement are secured by interests in all of our personalproperty, and proceeds from any intellectual property, but not by ourintellectual property.  The loanagreement contains conditions precedent that must be satisfied prior to anyborrowing and affirmative and negative covenants with which we mustcomply.  The loan agreement imposes restrictions with regards toadditional indebtedness, liens, various fundamental changes (including mergersand acquisitions), payments, investments, transactions with affiliates, andother limitations customary in secured credit facilities.  As of March 31, 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.

 

As of March 31, 2009, we have accumulatednet losses of $160.3 million. We expect to continue to incur operating lossesfor the remainder of 2009. We anticipate that our existing capital resourceswill permit us to meet our capital and operational requirements through atleast the end of 2010. We base this expectation on our current operating plan,which may change as a result of many factors.

 

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

 

·          sales of our marketed products;

·          expenditures related to our commercializationand development efforts;

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

·          results of research and development efforts;

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

·          technological advances;

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

·          acquisitions or investment in complimentarybusinesses, products or technologies.

 

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

 

·          conduct research and development programs;

·          conduct preclinical and clinical testing; and

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

 

Ourexisting capital resources may not be sufficient to fund our operationsuntil such time as we may be able to generate sufficient revenues tosupport our operations. We have limited credit facilities and, except for thecommon stock purchase agreement with Azimuth, we have no other committedsources of capital. To the extent that our capital resources are insufficientto meet our future capital requirements, we will have to raise additional fundsthrough the sale of our equity securities or from development and licensingarrangements to continue our development programs. We may be unable toraise such additional capital on favorable terms, or at all. If we raiseadditional capital by selling our equity or convertible debt securities, theissuance of such securities could result in dilution of our shareholders’equity positions. If adequate funds are not available we may have to:

 

·          delay, postpone or terminate clinical trials;

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

·          obtain funds through entering intocollaboration agreements on unattractive terms.

 

Theinability to raise additional capital would have a material adverse effect onour company.

 

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### **Cash Flows from Operating Activities**

### ** **

Cash provided byoperating activities during the three months ended March 31, 2009 wasapproximately $12.9 million, compared to cash used in operating activities ofapproximately $5.9 million for the three months ended March 31, 2008.  The increase in cash provided by operatingactivities for the three months ended March 31, 2009 as compared to cashused in operating activities three months ended March 31, 2008 wasprimarily due to an increase in deferred revenue as a result of the receipt ofthe $25.0 million upfront payment from Solvay in February 2009 offset byan increase in net loss for Q1 2009.

 

**CashFlows from Investing Activities**

 

Net cash used ininvesting activities during the three months ended March 31, 2009 wasapproximately $24.8 million and consisted primarily of a net increase inmarketable securities resulting from investment of the upfront payment receivedfrom Solvay in February 2009. Net cash provided by investing activitiesduring the three months ended March 31, 2008 was approximately $3.1 millionand consisted of net decrease in marketable securities.

 

**CashFlows from Financing Activities**

 

Cash used in financing activities during thethree months ended March 31, 2009 was approximately$0.7 million compared to cash provided by financing activities of approximately$3,000 for the same period in 2008. For the three months ended March 31,2009, cash used in financing activitiesprimarily consisted of repayments of principal on our credit facility. For the threemonths ended March 31, 2008, cash providedby financing activities consisted of cash proceeds from exercises ofstock options.

 

**ContractualObligations**

 

As of March 31,2009, our aggregate contractual obligations are as shown in the following table(in thousands):

 
| ** **                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Total** | ** ** |
|----------------------------|------------|-----------------------|------------|---------------|------------|---------------|------------|-----------|------------|
| Operating leases           |       | $                     | 1,587      |          | $          | 2,986         |       | $         | —     |   | $ | 4,573 |   |
| Long-term debt (principal) |       | 3,520                 |       | 5,166         |       | —        |       | 8,686     |       |
| Long-term debt (interest)  |       | 837                   |       | 427           |       | —        |       | 1,264     |       |
| Purchase commitments       |       | 1,034                 |       | —        |       | —        |       | 1,034     |       |
|                       |       | $                     | 6,978      |          | $          | 8,579         |       | $         | —     |   | $ | 15,557 |   |

 

At March 31, 2009, we had non-cancelablepurchase orders and minimum purchase obligations of approximately $0.8 millionunder our manufacturing agreement with Patheon Puerto Rico, Inc. for themanufacture of the 500mg GLUMETZA and $0.2 million under our supply agreementwith Biovail for the supply of the 1000mg GLUMETZA. The amounts disclosed onlyrepresent minimum purchase requirements. Actual purchases are expected toexceed these amounts.

 

The contractual obligations reflected in thistable exclude $3.0 million of contingent milestone payments we may be obligatedto pay in the future under our sublicense agreement with PharmaNova. Thesepayments relate to various milestones for the product candidate under thesublicense agreement, including dosing of the first patient in any Phase 3trial, submission to the FDA of an NDA, and FDA approval of an NDA. The abovetable also 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.

 

**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

There have been no significant changes in our market risk compared tothe disclosures in Item 7A of our Annual Report on Form 10-K for the yearended December 31, 2008.

 

**ITEM4. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controls and Procedures***

 

An evaluation was performed under the supervision and with theparticipation of our management, including the Company’s President and interimprincipal accounting and financial officer, of the effectiveness of the designand operation of our disclosure controls and procedures as of the end of theperiod covered by this quarterly report. Based on that evaluation, ourmanagement, including the Company’s President and interim principal accountingand financial officer, concluded that our disclosure controls and procedureswere effective.

 

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We review and evaluate the design and effectiveness of our disclosurecontrols and procedures on an ongoing basis to improve our controls andprocedures over time and to correct any deficiencies that we may discoverin the future. Our goal is to ensure that our senior management has timelyaccess to all material financial and non-financial information concerning ourbusiness. While we believe the present design of our disclosure controls andprocedures is effective to achieve our goal, future events affecting ourbusiness may cause us to significantly modify our disclosure controls andprocedures.

 

***Changes in Internal Controls***

 

There were no changes in our internal controls over financial reportingduring the quarter ended March 31, 2009 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

***Depomed v. IVAX***

 

Between January 2006and April 2008, we were involved in legal proceedings relating to some ofour intellectual property rights.  In January 2006, we filed acomplaint against IVAX Corporation (IVAX) in the U.S. District Court for theNorthern District of California for infringement of U.S. Patent Nos. 6,340,475and 6,635,280, both of which we own.  Thepatents relate to our AcuForm delivery technology. The complaint allegedinfringement of our patents by IVAX’s extended release metformin hydrochloridetablets.

 

In April 2008, weentered into a settlement and license agreement with Teva Pharmaceuticals USA, Inc.,an affiliate of IVAX, related to the litigation.  Pursuant to the settlement agreement:  (a) the parties dismissed the patentlitigation and released all claims associated with the litigation; (b) wereceived a one-time payment of $7.5 million in April 2008; (c) wegranted Teva a non-exclusive license to the Asserted Patents (including IVAX)to continue to market its generic Glucophage® XR (metformin hydrochloride extended releasetablets) product in the United States under the Asserted Patents; and (d) wewill receive ongoing royalty payments from Teva on sales by Teva (includingIVAX) of generic Glucophage XR in the United States.  The royalty issubject to a $2.5 million aggregate cap, and cumulatively through March 31,2009, we have recognized $1.6 million in royalty revenue under this agreement.

 

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

 

In December 2007,Apotex, Inc. (Apotex) filed the Canadian equivalent of an Abbreviated NewDrug Application in Canada seeking approval to market a generic version of the500mg formulation of GLUMETZA in Canada. Apotex’s regulatory filing alleges that certain of the Canadian patentsthat we have licensed to Biovail in connection with Biovail’s commercializationof GLUMETZA in Canada are invalid and unenforceable, and that Apotex’sformulation does not infringe our patents. Pursuant to the intellectual property enforcement provisions of ourCanadian license agreement with Biovail for GLUMETZA, Biovail has the firstright to prosecute, and pay for expenses related to, any Canadian litigationrelated to generic challenges to GLUMETZA. In January 2008, Biovail filed suit against Apotex in Canada inresponse to Apotex’s regulatory filing, and we have been joined to the lawsuitas a co-plaintiff with Biovail because we are the licensor of the patents atissue in the suit.  The initiation of thelawsuit automatically stays approval of Apotex’s formulation for 24 months. In October 2008,the court issued a ruling requiring that Apotex present its evidence in thecase by mid-January 2009, and that Biovail present its evidence by mid-April 2009. Eachparty has presented its evidence in the case. An adverse outcome in this mattercould substantially weaken our Canadian intellectual property.

 

**ITEM 1A.RISK FACTORS**

 

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

 

**Our prior Phase 3 trial for DM-1796 failed to meetthe primary efficacy endpoint and there can be no assurance this product willbe approved.**

 

In July 2007, weannounced that our drug candidate DM-1796 failed to meet the primary efficacyendpoint in a Phase 3 trial for postherpetic neuralgia (PHN).  In March 2008, we initiated anotherPhase 3 registration trial for the product for the PHN indication.

 

We submitted to the FDA aprotocol for a Phase 3 registration trial for DM-1796 to the FDA for a specialprotocol assessment, or SPA, pursuant to which we requested that the FDA assesswhether the protocol is adequate to meet the scientific and regulatoryrequirements necessary to support marketing approval of DM-1796 for PHN.  The FDA did provide us with guidance andcomments on our proposed protocol, but indicated that the protocol was noteligible for an SPA under FDA requirements. Accordingly, there can be no assurance that the FDA will approve DM-1796for PHN for marketing even if the primary endpoint in our current Phase 3 trialis met.

 

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**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 ourcontrol.**

 

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,which subjects us to a 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

 

**Ourclinical trials may not demonstrate that****Serada****TM**** ****for menopausal hot flashes is safe andeffective.  If our clinical trials of****Serada****for menopausal hotflashes do not demonstrate safety and efficacy, or if the clinical trials aredelayed or terminated, our business will be harmed.**

 

To gain regulatoryapproval from the FDA to market Serada for menopausal hot flashes, our plannedPhase 3 registration trials must demonstrate the safety and efficacy of theproduct candidate.  Clinical developmentis a long, expensive and uncertain process and is subject to delays.  The results of our Phase 2 clinical trial arenot necessarily indicative of the results we will obtain in later clinicaltrials.  Accordingly, future clinicaltrials may not demonstrate that Serada is effective for menopausal hot flashes.

 

In addition, dataobtained from pivotal clinical trials are susceptible to varyinginterpretations, which could delay, limit or prevent regulatory approval. Toobtain marketing approval, we may decide, or the FDA or other regulatoryauthorities may require us, to pursue additional pivotal clinical or otherstudies. These trials could significantly delay the approval andcommercialization of Serada for menopausal hot flashes and would require us tocommit significant additional financial resources. Even after we conduct theseadditional clinical trials, we may not receive regulatory approval to marketthe 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;

 

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·     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.

 

**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. We also have other product candidates in earlier stages ofdevelopment.

 

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.

 

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

 

Although we have the rights to promote GLUMETZAthrough our own sales force, or through third parties, we have no sales force andlimited marketing and sales staff.  Thesuccess of our own promotion efforts for GLUMETZA and any other productcandidates that receive regulatory approval that we choose to market orco-market, will require that we substantially enhance our in-house marketingand sales force with technical expertise, or make arrangements with thirdparties 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 besuccessful.  If we fail to fully developmarketing and sales capabilities, or enter into arrangements with thirdparties, our revenues may suffer.

 

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

 

We are responsible for the distribution of GLUMETZAand Proquin XR in the United States.  Ourin-house commercial operations and distribution capabilities are limited.  In addition, we have entered intodistribution arrangements with third parties, including Cardinal Health, AmerisourceBergenand McKesson, and we will depend on them to ensure that our marketed productsare widely available.  To continue tosupport our commercialization effort related to our marketed products, we mustcontinue to enhance our internal commercial infrastructure, and continue tocontract with capable third parties to assist us in our commercializationefforts.  The continued development ofthat infrastructure will also require substantial resources, whichmay divert the attention of our management and key personnel.  The efforts of third parties with whom wecontract for distribution of our products may not be successful.

 

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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 business and future revenues may beadversely affected.

 

**Our creditfacility 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. The credit facility is secured by a pledge ofall of our assets other than intellectual property, and contains a variety ofoperational covenants, including limitations on our ability to incur liens oradditional debt, make dispositions, pay dividends, redeem our stock, makecertain investments and engage in certain merger, consolidation or asset saletransactions and transactions with affiliates, among other restrictions.  Any future debt financing we enter into mayinvolve similar or more restrictive covenants affecting our operations.  Our borrowings under the credit facility orany future debt financing will need to be repaid, which creates additionalfinancial risk for our company, particularly if our business, or prevailingfinancial market conditions, are not conducive to paying off or refinancing ouroutstanding debt obligations. Furthermore, our failure to comply with thecovenants in the credit facility could result in an event of default that, ifnot cured or waived, could result in the acceleration of all or a substantialportion of our debt, which could have a material adverse effect on our cashposition and significantly harm our business.

 

**Our existing resources may not besufficient to fund our operations until such time as we may be able to 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 generate sufficient revenues to support our operations.  We have limited credit facilities and, exceptfor our common stock purchase agreement with Azimuth, we have no othercommitted sources of capital.  Our latestage clinical development programs will require considerable financialresources, and we may not be successful in entering into development andmarketing arrangements in which a collaborative partner will pay for the costsof those programs. To the extent that our capital resources are insufficient tomeet our future capital requirements, we will have to raise additional fundsthrough the sale of our equity securities or from development and licensingarrangements to continue our development programs. We may be unable to raisesuch additional capital on favorable terms, or at all. If we raise additionalcapital by selling our equity or convertible debt securities, the issuance ofsuch securities could result in dilution of our shareholders’ equity positions.If adequate funds are not available we may have to:

 

·                  delay, postpone or terminate clinical trials;

 

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

 

·                  obtain funds through entering into collaborationagreements on unattractive terms.

 

Some economists are now predictingthat the United States economy, and possibly the global economy, may enter intoa prolonged downturn or recession as a result of recent economic events,including the deterioration of the credit and capital markets and relatedfinancial crisis.  Though the ultimate effect of these developments cannotbe predicted, they may have a material adverse effect on our liquidity andfinancial condition and our ability to raise additional funds, whether pursuantto our existing or future financing arrangements.  In addition, if thesedevelopments negatively impact the ability of our collaborative partners todevelop, manufacture, promote or commercialize our products and productcandidates, our revenues may suffer and our business, financial condition andresults of operations could be materially and adversely affected. Similarly, any negative impact of an economic downturn or recession on ourpotential collaborative partners could adversely affect the terms on whichcollaborative partnerships may be available to us, if at all.

 

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

 

To date, we have recorded revenues from license fees,product sales, royalties, collaborative research and development arrangementsand feasibility studies.  For the threemonths ended March 31, 2009, we recorded total revenues of $9.9 millionand for the years ended December 31, 2008, 2007 and 2006, we recordedtotal revenue of $34.8 million, $65.6 million, and $9.6 million, respectively.For the three months ended March 31, 2009, we incurred a net loss of $10.2million and for the years ended December 31, 2008 and 2006 we incurred netlosses of $15.3 million and $39.7 million, respectively. The termination of ourlicense agreement with Esprit in July 2007, including the acceleratedrecognition of previously deferred revenue under the arrangement, andtermination fees received associated with the termination of our promotionagreement with King resulted in our reaching profitability in 2007. However, aswe continue our research and development efforts, preclinical testing andclinical trial activities, we anticipate that we will incur operating lossesfor the remainder of 2009.  Therefore, weexpect our cumulative losses to increase. These losses, among other things,have had, and we expect that they will continue to have, an adverse impact onour total assets, shareholders’ equity and working capital.

 

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

 

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

 

·                  results of clinical trials for our product candidates;

 

·                  announcements regarding clinical trial results and plans for our drugcandidates, including DM-1796 and Serada;

 

·                  the degree of commercial success of GLUMETZA;

 

·                  regulatory actions;

 

·                  adverse events related to our products, including recalls;

 

·                  interruptions of manufacturing or supply;

 

·                  results of litigation;

 

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

 

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

 

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

 

·                  market acceptance of the AcuForm technology;

 

·                  adoption of new technologies by us or our competitors;

 

·                  the introduction of new products by our competitors;

 

·                  manufacturing costs and difficulties;

 

·                  third-party reimbursement policies; and

 

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

 

As a result of these factors, our stock price maycontinue to be volatile and investors may be unable to sell their shares at aprice equal to, or above, the price paid. Additionally, any significant dropsin our stock price, such as the one we experienced following the announcementof our DM-1796 Phase 3 trial results in July 2007, 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, Covidien, and Patheon, Inc.  In addition, we have in the past andmay in the future enter into other collaborative arrangements, some ofwhich have been based on less definitive agreements, such as memoranda ofunderstanding, material transfer agreements, options or feasibilityagreements.  We may not executedefinitive agreements formalizing these arrangements.  Collaborative relationships are generallycomplex and may give rise to disputes regarding the relative rights,obligations and revenues of the parties, including the ownership ofintellectual property and associated rights and obligations, especially whenthe applicable collaborative provisions have not been fully negotiated anddocumented. Such disputes can delay collaborative research, development orcommercialization of potential products, and can lead to lengthy, expensivelitigation or arbitration. The terms of collaborative arrangements may alsolimit or preclude us from developing products or technologies developedpursuant to such collaborations. Additionally, the collaborators under thesearrangements might breach the terms of their respective agreements or fail toprevent infringement of the licensed patents by third parties. Moreover,negotiating collaborative arrangements often takes considerably longer toconclude than the parties initially anticipate, which could cause us to enterinto less favorable agreement terms that delay or defer recovery of ourdevelopment costs and reduce the funding available to support key programs.

 

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

 

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

 

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

 

·                  premature termination of acollaboration agreement; or

 

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

 

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 in collaborationwith us. Our collaborative partners may also terminate their collaborativerelationships with us or otherwise decide not to proceed with development andcommercialization of our products.

 

**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 to protectour proprietary rights, by, among other methods, filing patent applications inthe United States and foreign jurisdictions to cover certain aspects of ourtechnology. We currently hold ten issued United States patents, and haveseventeen patent applications pending in the United States.  In addition,we are preparing patent applications relating to our expanding technology forfiling in the United States and abroad.  We have also applied for patentsin numerous foreign countries. Some of those countries have granted ourapplications and other applications are still pending. Our pending patentapplications may lack priority over others’ applications or may not result inthe issuance of patents. Even if issued, our patents may not be sufficientlybroad to provide protection against competitors with similar technologies andmay be challenged, invalidated or circumvented, which could limit our abilityto stop competitors from marketing related products or may not provide us withcompetitive advantages against competing products. We also rely on tradesecrets and proprietary know-how, which are difficult to protect. We seek toprotect such information, in part, through entering into confidentialityagreements with employees, consultants, collaborative partners and othersbefore such persons or entities have access to our proprietary trade secretsand know-how. These confidentiality agreements may not be effective in certaincases, due to, among other things, the lack of an adequate remedy for breach ofan agreement or a finding that an agreement is unenforceable. In addition, ourtrade secrets may otherwise become known or be independently developed bycompetitors.

 

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

 

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

 

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

 

** **We have anexclusive sublicense from PharmaNova, Inc. to a patent held by theUniversity of Rochester to develop and commercialize in the United States agabapentin product for the treatment of hot flashes associated withmenopause.  Because a method-of-usepatent, such as the patent we have sublicensed from PharmaNova, covers only aspecified use of a particular compound, not a particular composition of matter,we cannot prevent others from commercializing gabapentin.  Accordingly, physicians could prescribeanother manufacturer’s gabapentin to treat hot flashes in menopausal womenrather than Serada, or pharmacists could seek to fill prescriptions for Seradawith another manufacturer’s gabapentin. Although any such “off-label” use would violate our licensed patent,effectively monitoring compliance with our licensed patent may be difficult andcostly.

 

**Itis difficult to develop a successful product. If we do not develop a successfulproduct, our financial position and liquidity will be adversely affected.**

 

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 than GLUMETZAand Proquin XR, we, our current and any future collaborative partners will needto:

 

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

 

·                  obtain regulatory approval from the FDA or foreign regulatoryauthorities.

 

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

 

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

 

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

 

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

 

·                  market acceptance;

 

·                  cost-effective commercial scale production; and

 

·                  reimbursement under private or governmental health plans.

 

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

 

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

 

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

 

·                  our available capital resources;

 

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

 

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

 

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

 

·                  other actions by regulators;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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Further, with respect to our approved products, onceregulatory approval is obtained, a marketed product and its manufacturer aresubject to continual review. The discovery of previously unknown problems witha product or manufacturer may result in restrictions on the product,manufacturer or manufacturing facility, including withdrawal of the productfrom the market. Manufacturers of approved products are also subject to ongoingregulation, including compliance with FDA regulations governing current GoodManufacturing Practices (cGMP). Failure to comply with manufacturingregulations can result in, among other things, warning letters, fines,injunctions, civil penalties, recall or seizure of products, total or partialsuspension of production, refusal of the government to renew marketingapplications and criminal prosecution.

 

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

 

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

 

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

 

To market any of our products outside of the UnitedStates, we and our collaborative partners, including Madaus, are subject tonumerous and varying foreign regulatory requirements, implemented by foreignhealth authorities, governing the design and conduct of human clinical trialsand marketing approval for drug products. The approval procedure varies amongcountries and can involve additional testing, and the time required to obtainapproval may differ from that required to obtain FDA approval. The 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.

 

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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 the AcuForm technologyinclude Bristol-Myers Squibb, IVAX Corporation (a subsidiary of TEVAPharmaceutical Industries, Ltd.), ALZA Corporation (a subsidiary of Johnson &Johnson), SkyePharma plc, Biovail Corporation, Flamel Technologies S.A.,Ranbaxy Laboratories, Ltd., Kos Pharmaceuticals, Inc., Intec Pharma andAlpharma, Inc., all of which develop oral tablet products designed torelease the incorporated drugs over time. Each of these companies has patentedtechnologies with attributes different from ours, and in some cases withdifferent sites of delivery to the gastrointestinal tract.

 

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

 

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

 

Gabapentinis currently marketed by Pfizer as Neurontin for adjunctive therapy forepileptic seizures and for postherpetic pain. Pfizer’s basic U.S. patentsrelating to Neurontin have expired, and numerous companies have receivedapproval to market generic versions of the immediate release product. Inaddition, Pfizer has developed  Lyrica®(pregabalin), which has been approved for marketing in the United States andthe 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, and continueto devote, significant resources to the development of their own drug deliverysystems and technologies.

 

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

 

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

 

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 from UquifaMexico, S.A., a sole supplier to us, on a purchase order basis. We will also beresponsible for the manufacture of bulk Proquin XR tablets to Madaus for theEuropean market, if the product is approved for marketing in Europeanjurisdictions.  We intend to purchaseProquin XR tablets from Patheon, Puerto Rico, Inc. for that purpose. 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.

 

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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 Phase 3 clinical trials and commercialization. Our dependenceon third parties for the manufacture of products using the AcuForm technologymay adversely affect our ability to deliver such products on a timely orcompetitive basis.  The manufacturingprocesses of our third party manufacturers may be found to violate theproprietary rights of others. If we are unable to contract for a sufficientsupply of required products on acceptable terms, or if we encounter delays anddifficulties in our relationships with manufacturers, the market introductionand commercial sales of our products will be delayed, and our future revenuewill suffer.

 

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

 

Ourbusiness involves exposure to potential product liability risks that areinherent in the development and production of pharmaceutical products. We haveobtained product liability insurance for clinical trials currently underway andforecasted 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 thecommercialization of the AcuForm technology proceeds; or

 

·                  our insurance may not provide adequate protection against potentialliabilities.

 

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

 

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

 

Oursuccess is dependent in large part upon the continued services of our Presidentand Chief Executive Officer, Carl A. Pelzel, and other members of our executivemanagement team, and on our ability to attract and retain key management andoperating personnel. We do not have agreements with Mr. Pelzel or any ofour other executive officers that provide for their continued employment withus. Our former Chairman, President and Chief Executive Officer retired in August 2007,and our Chief Financial Officer retired in October 2007; we have not yetreplaced our Chief Financial Officer on a permanent basis.  We may have difficulty filling open seniorscientific, financial and commercial positions. Management, scientific andoperating personnel are in high demand in our industry and are often subject tocompeting offers. The loss of the services of one or more members of managementor key employees or the inability to hire additional personnel as needed couldresult in delays in the research, development and commercialization of ourproducts 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 or technologyor retain any key employees. Integrating any business, product or technology weacquire could be expensive and time consuming, disrupt our ongoing business anddistract our management. If we were to be unable to integrate any acquiredbusinesses, products or technologies effectively, our business would suffer. Inaddition, any amortization or charges resulting from the costs of acquisitionscould harm our operating results.

 

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**We have implemented certain anti-takeover provisions.**

 

Certain provisions of our articles of incorporation and the CaliforniaGeneral Corporation Law could discourage a third party from acquiring, or makeit more difficult for a third party to acquire, control of our company withoutapproval of our board of directors. These provisions could also limit the pricethat certain investors might be willing to pay in the future for shares of ourcommon stock. Certain provisions allow the board of directors to authorize theissuance of preferred stock with rights superior to those of the common stock.We are also subject to the provisions of Section 1203 of the California GeneralCorporation Law which requires a fairness opinion to be provided to ourshareholders in connection with their consideration of any proposed “interestedparty” reorganization transaction.

 

We have adopted a shareholder rights plan, commonly known as a “poisonpill”. The provisions described above, our poison pill and provisions of theCalifornia General Corporation Law may discourage, delay or prevent a thirdparty from acquiring us.

 

**Increasedcosts associated with corporate governance compliance may significantly impactour results of operations.**

 

Changing laws, regulations and standardsrelating to corporate governance, public disclosure and compliance practices,including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ GlobalMarket rules, are creating uncertainty for companies such as ours inunderstanding and complying with these laws, regulations and standards.  As a result of this uncertainty and otherfactors, devoting the necessary resources to comply with evolving corporate governanceand public disclosure standardshas resulted in and may in the future result in increased general andadministrative expenses and a diversion of management time and attention tocompliance activities.  We also expectthese developments to increase ourlegal compliance and financial reporting costs. In addition, these developments may make it more difficult and moreexpensive for us to obtain director and officer liability insurance, and we maybe required to accept reduced coverage or incur substantially higher costs toobtain coverage.  Moreover, we may beunable to comply with these new rules and regulations on a timely basis.

 

These developments could make it more difficult for us to attract andretain qualified members of our board of directors, or qualified executiveofficers.  We are presently evaluatingand monitoring regulatory developments and cannot estimate the timing ormagnitude 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 wesell shares of our common stock under our equity line of credit arrangement orin other future financings, existing common shareholders will experienceimmediate dilution and, as a result, our stock price may go down.**

 

We may from time to time issue additional shares of common stock at adiscount from the current trading price of our common stock.  As a result, our existing common shareholderswill experience immediate dilution upon the purchase of any shares of ourcommon stock sold at such discount.  Forexample, in December 2006, we entered into a common stock purchaseagreement with Azimuth Opportunity Ltd., pursuant to which we may sell sharesof common stock at a discount to the prevailing market price ranging fromapproximately 3.8% to 6.4%, excluding an additional placement agent fee ofapproximately 1.1% payable by us on the gross offering proceeds. In addition,as other capital raising opportunities present themselves, we may enter into financingor 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.

 

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

 

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

 

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**Business interruptions could limit our ability tooperate 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 damagesincurred by us and require us to cease or curtail our operations.

 

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

 

Not applicable.

 

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

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM 5.  OTHER INFORMATION**

 

Not applicable.

 

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**ITEM 6. EXHIBITS**

 
| (a)    |   | Exhibits |   |                                                                                                                                  |
|--------|--------|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------|
|   |   | 10.1     |   | Amendment to Amended and Restated Promotion  Agreement dated February 18, 2009 between the Company and Watson  Pharma, Inc. |
|   |   | 10.2     |   | Form of Management Continuity Agreement between  the Company and certain officers of the Company                                 |
|   |   | 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**

##### ** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 

| Date: May 5, 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 and Interim Principal  Accounting and Financial Officer |

 

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