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

 

**COMMISSION FILE NUMBER 001-13111**

 

**DEPOMED, INC.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

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

 

**1360 O’BRIEN DRIVE**

**MENLO PARK, CALIFORNIA 94025**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

 

**(650) 462-5900**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

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

 

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

 

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

 

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

 

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

 

Thenumber of issued and outstanding shares of the Registrant’s Common Stock, nopar value, as of August 6th, 2009 was 51,609,307.

 

 

 

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Table of Contents

 

**DEPOMED, INC.**

 
| ** **                                                                                                      | **PAGE**   |
|-----------------------------------------------------------------------------------------------------------------|------------|
|                                                                                                            |       |
| **PART I —  FINANCIAL INFORMATION**                                                                   | ** ** |
|                                                                                                            |       |
| Item 1.  Condensed Financial Statements:                                                                        |       |
|                                                                                                            |       |
| Condensed Balance  Sheets at June 30, 2009 (unaudited) and December 31, 2008                          | 3          |
|                                                                                                            |       |
| Condensed  Statements of Operations for the three and six months ended June 30,  2009 and 2008 (unaudited) | 4          |
|                                                                                                            |       |
| Condensed  Statements of Cash Flows for the six months ended June 30, 2009 and 2008  (unaudited)           | 5          |
|                                                                                                            |       |
| Notes to  Condensed Financial Statements (unaudited)                                                            | 6          |
|                                                                                                            |       |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations            | 18         |
|                                                                                                            |       |
| Item 3.  Quantitative and Qualitative Disclosure About Market Risk                                              | 27         |
|                                                                                                            |       |
| Item 4. Controls  and Procedures                                                                                | 28         |
|                                                                                                            |       |
| **PART II — OTHER  INFORMATION**                                                                      | ** ** |
|                                                                                                            |       |
| Item 1. Legal  Proceedings                                                                                      | 29         |
|                                                                                                            |       |
| Item 1A. Risk Factors                                                                                           | 29         |
|                                                                                                            |       |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                            | 41         |
|                                                                                                            |       |
| Item 3.  Defaults upon Senior Securities                                                                        | 41         |
|                                                                                                            |       |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                    | 41         |
|                                                                                                            |       |
| Item 5. Other  Information                                                                                      | 41         |
|                                                                                                            |       |
| Item 6. Exhibits                                                                                                | 42         |
|                                                                                                            |       |
| Signatures                                                                                                      | 43         |

 

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**PART I— FINANCIAL INFORMATION**

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

###### ** **

**DEPOMED, INC.**

**CONDENSEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                             | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                                                             | ** ** | **(Unaudited)**   | ** ** | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                                                             | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                                                        |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                              |       | $                 | 8,153      |                  | $          | 22,127 |   |
| Marketable securities                                                                                                                                                                                                                  |       | 59,659            |       | 59,932                |       |
| Accounts receivable                                                                                                                                                                                                                    |       | 4,154             |       | 3,099                 |       |
| Unbilled accounts receivable                                                                                                                                                                                                           |       | 564               |       | 576                   |       |
| Inventories                                                                                                                                                                                                                            |       | 2,366             |       | 2,849                 |       |
| Prepaid and other current assets                                                                                                                                                                                                       |       | 1,979             |       | 5,404                 |       |
| Total current assets                                                                                                                                                                                                                   |       | 76,875            |       | 93,987                |       |
| Marketable securities                                                                                                                                                                                                                  |       | 16,169            |       | —                |       |
| Property and equipment, net                                                                                                                                                                                                            |       | 666               |       | 900                   |       |
| Other assets                                                                                                                                                                                                                           |       | 197               |       | 197                   |       |
|                                                                                                                                                                                                                                   |       | $                 | 93,907     |                  | $          | 95,084 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                                                                   |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                                                                       |       | $                 | 865        |                  | $          | 559 |   |
| Accrued compensation                                                                                                                                                                                                                   |       | 1,559             |       | 2,601                 |       |
| Accrued clinical trial expense                                                                                                                                                                                                         |       | 1,098             |       | 661                   |       |
| Other accrued liabilities                                                                                                                                                                                                              |       | 8,229             |       | 9,027                 |       |
| Deferred product sales                                                                                                                                                                                                                 |       | 1,618             |       | 1,702                 |       |
| Deferred license revenue                                                                                                                                                                                                               |       | 10,684            |       | 4,362                 |       |
| Other current liabilities                                                                                                                                                                                                              |       | 132               |       | 110                   |       |
| Current portion of long-term debt                                                                                                                                                                                                      |       | 3,528             |       | 3,356                 |       |
| Total current liabilities                                                                                                                                                                                                              |       | 27,713            |       | 22,378                |       |
| Deferred license revenue, non-current portion                                                                                                                                                                                          |       | 46,648            |       | 33,209                |       |
| Long-term debt, non-current portion                                                                                                                                                                                                    |       | 4,099             |       | 5,775                 |       |
| Other long-term liabilities                                                                                                                                                                                                            |       | 542               |       | 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  June 30, 2009 and December 31, 2008 |       | —            |       | —                |       |
| Common stock, no par value, 100,000,000 shares  authorized; 51,352,266 and 51,171,377 shares issued and outstanding at  June 30, 2009 and December 31, 2008, respectively                                                    |       | 184,747           |       | 183,196               |       |
| Accumulated deficit                                                                                                                                                                                                                    |       | (169,964          | )          | (150,194              | )          |
| Accumulated other comprehensive gain                                                                                                                                                                                                   |       | 122               |       | 151                   |       |
| Total shareholders’ equity                                                                                                                                                                                                        |       | 14,905            |       | 33,153                |       |
|                                                                                                                                                                                                                                   |       | $                 | 93,907     |                  | $          | 95,084 |   |

 

----

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

 

See accompanying notes to CondensedFinancial Statements.

 

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**DEPOMED, INC.**

**CONDENSED STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                                          | ** ** | **2009**                              | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                                                           |       |                                  |       |                               |       |   |   |   |   |
| Product sales                                                                       |       | $                                     | 8,408      |                               | $          | 5,519 |   | $ | 15,248 |   | $ | 10,745 |   |
| Royalties                                                                           |       | 529                                   |       | 433                                |       | 993 |   | 545 |   |
| License revenue                                                                     |       | 2,671                                 |       | 363                                |       | 5,239 |   | 727 |   |
| Total revenues                                                                      |       | 11,608                                |       | 6,315                              |       | 21,480 |   | 12,017 |   |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Costs and expenses:                                                                 |       |                                  |       |                               |       |   |   |   |   |
| Cost of sales                                                                       |       | 1,229                                 |       | 962                                |       | 2,261 |   | 2,171 |   |
| Research and development                                                            |       | 10,024                                |       | 4,680                              |       | 20,045 |   | 10,750 |   |
| Selling, general and administrative                                                 |       | 9,945                                 |       | 5,241                              |       | 18,947 |   | 11,748 |   |
| Gain on litigation settlement                                                       |       | —                                |       | (7,500                             | )          | — |   | (7,500 | ) |
| Total costs and expenses                                                            |       | 21,198                                |       | 3,383                              |       | 41,253 |   | 17,169 |   |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Income (loss) from operations                                                       |       | (9,590                                | )          | 2,932                              |       | (19,773 | ) | (5,152 | ) |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Other income (expense):                                                             |       |                                  |       |                               |       |   |   |   |   |
| Interest and other income                                                           |       | 236                                   |       | 553                                |       | 550 |   | 1,356 |   |
| Interest expense                                                                    |       | (263                                  | )          | (5                                 | )          | (548 | ) | (5 | ) |
| Total other income (expense)                                                        |       | (27                                   | )          | 548                                |       | 2 |   | 1,351 |   |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Net income (loss) before income taxes                                               |       | (9,617                                | )          | 3,480                              |       | (19,771 | ) | (3,801 | ) |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Provision for income taxes                                                          |       | 2                                     |       | —                             |       | 1 |   | — |   |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Net income (loss)                                                                   |       | (9,615                                | )          | 3,480                              |       | (19,770 | ) | (3,801 | ) |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Deemed dividend on preferred stock                                                  |       | —                                |       | (180                               | )          | — |   | (355 | ) |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Net income (loss) applicable to common stock  shareholders                          |       | $                                     | (9,615     | )                                  | $          | 3,300 |   | $ | (19,770 | ) | $ | (4,156 | ) |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Basic net income (loss) applicable to common stock  shareholders per common share   |       | $                                     | (0.19      | )                                  | $          | 0.07 |   | $ | (0.39 | ) | $ | (0.09 | ) |
| Diluted net income (loss) applicable to common stock  shareholders per common share |       | $                                     | (0.19      | )                                  | $          | 0.07 |   | $ | (0.39 | ) | $ | (0.09 | ) |
|                                                                                |       |                                  |       |                               |       |   |   |   |   |
| Shares used in computing basic net income (loss) per  common share                  |       | 51,263,620                            |       | 48,041,855                         |       | 51,235,735 |   | 47,954,052 |   |
| Shares used in computing diluted net income (loss)  per common share                |       | 51,263,620                            |       | 48,405,333                         |       | 51,235,735 |   | 47,954,052 |   |

 

See accompanying notes to Condensed Financial Statements.

 

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**DEPOMED, INC.**

**CONDENSED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Operating Activities**                                                                   | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                                  | (19,770    | ) | $ | (3,801 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                               |       |   |   |
| Depreciation and amortization                                                              |       | 520                                |       | 631 |   |
| Employee and director stock-based compensation                                             |       | 1,332                              |       | 1,135 |   |
| Stock-based compensation related to consultants                                            |       | 21                                 |       | 87 |   |
| Changes in assets and liabilities:                                                         |       |                               |       |   |   |
| Accounts receivable                                                                        |       | (1,044                             | )          | (264 | ) |
| Inventories                                                                                |       | 483                                |       | (284 | ) |
| Prepaid and other current assets                                                           |       | 3,425                              |       | (1,079 | ) |
| Accounts payable and other accrued liabilities                                             |       | (58                                | )          | 124 |   |
| Accrued compensation                                                                       |       | (1,043                             | )          | (192 | ) |
| Deferred revenue                                                                           |       | 19,677                             |       | 1,913 |   |
| Net cash provided by (used in) operating activities                                        |       | 3,543                              |       | (1,730 | ) |
|                                                                                       |       |                               |       |   |   |
| **Investing Activities**                                                                   | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                        |       | (170                               | )          | (147 | ) |
| Purchases of marketable securities                                                         |       | (81,810                            | )          | (23,206 | ) |
| Maturities of marketable securities                                                        |       | 55,812                             |       | 44,757 |   |
| Sales of marketable securities                                                             |       | 10,008                             |       | 11,159 |   |
| Net cash (used in) provided by investing activities                                        |       | (16,160                            | )          | 32,563 |   |
|                                                                                       |       |                               |       |   |   |
| **Financing Activities**                                                                   | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Proceeds from long-term debt                                                               |       | —                             |       | 3,800 |   |
| Principal payments on long-term debt                                                       |       | (1,554                             | )          | — |   |
| Debt issuance costs                                                                        |       | —                             |       | (288 | ) |
| Proceeds from issuance of common stock                                                     |       | 197                                |       | 215 |   |
| Net cash (used in) provided by financing activities                                        |       | (1,357                             | )          | 3,727 |   |
|                                                                                       |       |                               |       |   |   |
| Net (decrease) increase in cash and cash equivalents                                       |       | (13,974                            | )          | 34,560 |   |
| Cash and cash equivalents at beginning of period                                           |       | 22,127                             |       | 14,374 |   |
| Cash and cash equivalents at end of period                                                 |       | $                                  | 8,153      |   | $ | 48,934 |   |

 

See accompanying notes to Condensed Financial Statements.

 

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**DEPOMED, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

## ***Basis of Presentation***

## * *

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

 

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

 

***Use of Estimates***

 

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

 

***Stock-BasedCompensation***

* *

The Company calculates stock-based compensation forall periods presented in accordance with Statement of Financial AccountingStandards No. 123 (revised 2004), *Share-Based Payment*(FAS 123(R)), as interpreted by SEC Staff Accounting Bulletin No. 107 (SAB107), using the modified prospective transition method. FAS 123(R) 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. The compensation expense forstock-based compensation is based on the single-option approach, includes anestimate for forfeitures and is recognized over the vesting term of the optionsusing the straight-line method. FAS 123(R) requires forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates. Depomed estimatesforfeitures based on historical experience. See Note 6 of the Notes toCondensed Financial Statements for further information regarding Depomed’s stock-basedcompensation expense.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

***Revenue Recognition***

 

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

 

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

 

·                  Product Sales:

 

·                  *GLUMETZA**®*: The Company began selling GLUMETZA*®* (metformin hydrochloride extended releasetablets) in August 2006 to wholesalers and retail pharmacies that issubject to rights of return six months before expiration and up to twelvemonths after product expiration. Beginning in the third quarter of 2008, theCompany began recognizing revenue for GLUMETZA sales at the time titletransfers to its customers, which occurs at the time product is delivered toits customers.  Prior to the thirdquarter of 2008, the Company was unable to reasonably estimate expected returnsof the product at the time of shipment, and therefore, deferred revenue onproduct shipments of GLUMETZA until the product was dispensed through patientprescriptions. The quantity of prescription units dispensed was estimated basedon an analysis of third-party information, including third-party marketresearch data and information obtained from wholesalers with respect toinventory levels and inventory movement. Based on the actual shipment trends,prescription trends and product returns history for GLUMETZA and based on an analysisof return rates of companies with products that have similar characteristicsand similar return policies within the metformin prescription market, theCompany concluded it had the information needed to reasonably estimate productreturns beginning in the third quarter of 2008.

 

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

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

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

 

In April 2008, theCompany entered into a settlement and license agreement with TevaPharmaceuticals USA, Inc. (Teva) in which the Company is entitled toreceive royalties from Teva on sales by Teva or its affiliates of genericGlucophage®XR in the United States, subject to a $2.5 million aggregate cap.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.

 

Royalties received underthe Company’s agreements with Biovail Laboratories s.r.l. (Biovail) and LG LifeSciences (LG) are recognized when the royalty payments are received as they arenot estimable.

 

·                  License Revenue- Revenue from license arrangements is recognized when the Company hassubstantially completed its obligations under the terms of the arrangement andthe Company’s remaining involvement is inconsequential and perfunctory. If theCompany has significant continuing involvement under such an arrangement,license fees are recognized over the estimated performance period. License feepayments received in excess of amounts earned are classified as deferredrevenue until earned.

 

***Recently Issued AccountingStandards***

* *

In April 2009, theFASB issued Statement of Financial Position (FSP FAS) No. 157-4, *Determining Fair Value When the Volume and Level of Activity for theAsset or Liability Have Significantly Decreased and Identifying TransactionsThat Are Not Orderly*, and is effective for the Company beginning July 1,2009.  FSP FAS 157-4 provides additionalguidance for estimating fair value in accordance with FASB Statement No. 157,*Fair Value Measurements*, when the volumeand level of activity for the asset or liability have significantly decreasedand includes guidance on identifying circumstances that indicate a transactionis not orderly. During the quarter ended June 30, 2009, the Companyadopted FAS 157-4. The adoption of FAS 157-4 did not have a material effect onits financial statements.

 

In April 2009, theFASB issued Statement of Financial Position (FSP FAS) No. 115-2 and No. 124-2,*Recognition and Presentation ofOther-Than-Temporary Impairments*, and is effective for the Companybeginning July 1, 2009. FSP FAS 115-2 and 124-2 amend theother-than-temporary impairment guidance in US GAAP for the debt securities tomake the guidance more operational and to improve the presentation anddisclosure of other-than-temporary impairments of debt and equity securities.During the quarter ended June 30, 2009, the Company adopted FSP FAS 115-2and 124-2. The adoption of FSP FAS 115-2 and 124-2 did not have a materialeffect on the Company’s financial statements.

 

In May 2009, theFASB issued Statement of Financial Accounting StandardsNo. 165, *Subsequent Events*(FAS 165), which establishes generalstandards of accounting for and disclosure of events that occur after thebalance sheet date but before financial statements are issued or are availableto be issued. This statement sets forth the circumstances under which anentity should recognize events or transactions occurring after the balancesheet date in its financial statements. FAS 165 also requires disclosure of thedate through which an entity has evaluated subsequent events and the basis forthat date—that is, whether that date represents the date the financialstatements were issued or were available to be issued. During the quarterended June 30, 2009, the Company adopted FAS 165. The adoption of FAS 165did not have a significant impact on the Company’s condensed financialstatements or related footnotes. See Note 12 of the Notes to CondensedFinancial Statements for further information on the Company’s subsequentevents.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

InJune 2009, the FASB issued Statement of Financial Accounting Standards No. 168,*The FASB Accounting Standards Codification and theHierarchy of Generally Accepted Accounting Principles—a replacement of FASBStatement No. 162* (FAS 168). The statement confirmed that theFASB Accounting Standards Codification (the Codification) will become thesingle official source of authoritative U.S. GAAP (other than guidanceissued by the SEC), superseding existing FASB, American Institute of CertifiedPublic Accountants, Emerging Issues Task Force, and related literature. Afterthat date, only one level of authoritative U.S. GAAP will exist. All otherliterature will be considered non-authoritative. The Codification does notchange U.S. GAAP; instead, it introduces a new structure that is organizedin an easily accessible, user-friendly online research system. TheCodification, which changes the referencing of financial standards, becomeseffective for interim and annual periods ending on or after September 15,2009. The Company will apply the Codification beginning in the third quarter offiscal 2009. The adoption of FAS 168 is not expected to have any substantiveimpact on the Company’s financial statements.

 

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

 

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

 
| **June 30, 2009**                                                       | ** ** | **Amortized  Cost** | ** ** | **Gross**

**Unrealized  Gains** | ** ** | **Gross  Unrealized**

**Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------|------------|----------------------------------|------------|-----------------------------------|------------|----------------|------------|
| U.S. debt securities:                                                        |       |                |       |                             |       |                              |       |           |       |
| Total included in cash and  cash equivalents                                 |       | $                   | 2,388      |                             | $          | —                            |       | $              | —     |   | $ | 2,388 |   |
| Total maturing within 1  year and included in marketable securities:         |       |                |       |                             |       |                              |       |           |       |
| Commercial paper                                                             |       | 10,193              |       | 2                                |       | (5                                | )          | 10,190         |       |
| U.S. corporate debt  securities                                              |       | 11,929              |       | 25                               |       | (35                               | )          | 11,919         |       |
| U.S. government agency  debt securities                                      |       | 36,942              |       | 23                               |       | —                            |       | 36,965         |       |
| U.S. Treasury securities                                                     |       | 3,080               |       | 3                                |       | —                            |       | 3,083          |       |
| Total maturing between 1  and 2 years and included in marketable securities: |       |                |       |                             |       |                              |       |           |       |
| Commercial paper                                                             |       | —              |       | —                           |       | —                            |       | —         |       |
| U.S. corporate debt securities                                               |       | 7,062               |       | 64                               |       | (2                                | )          | 7,124          |       |
| U.S. government agency  debt securities                                      |       | 8,999               |       | 47                               |       | —                            |       | 9,046          |       |
| U.S. Treasury securities                                                     |       | —              |       | —                           |       | —                            |       | —         |       |
| Total available-for-sale                                                     |       | $                   | 80,593     |                             | $          | 164                               |       | $              | (42        | ) | $ | 80,715 |   |

 
| **December 31,  2008**                                                  |   | **Amortized  Cost** |   | **Gross  Unrealized**

**Gains** |   | **Gross  Unrealized**

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

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

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

 

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

 
| ** **                     | ** ** | **Less than 12 months** | ** ** | **12 months or greater**      | ** ** | **Total**      | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------------------|------------|----------------|------------|
| **U.S. Debt Securities**       | ** ** | **Fair Value**          | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| Commercial paper               |       | $                       | 2,993      |                          | $          | (5             | )          | $ | — |   | $ | — |   | $ | 2,993 |   | $ | (5 | ) |
| U.S. corporate debt securities |       | 11,624                  |       | (37                           | )          | —         |       | — |   | 11,624 |   | (37 | ) |
| Total available-for-sale       |       | $                       | 14,617     |                          | $          | (42            | )          | $ | — |   | $ | — |   | $ | 14,617 |   | $ | (42 | ) |

 

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

 

EffectiveJanuary 1, 2008, the Company adopted Statement of Financial AccountingStandards No. 157, Fair Value Measurements (FAS 157). FAS 157 defines fairvalue, establishes a framework for measuring fair value under generallyaccepted accounting principles and enhances disclosures about fair valuemeasurements. Fair value is defined under FAS 157 as the exchange price thatwould be received for an asset or paid to transfer a liability (an exit price)in the principal or most advantageous market for the asset or liability in anorderly transaction between market participants on the measurement date.Valuation techniques used to measure fair value under FAS 157 must maximize theuse of observable inputs and minimize the use of unobservable inputs. Thestandard describes a fair value hierarchy based on three levels of inputs, ofwhich the first two are considered observable and the last unobservable, thatmay be used to measure fair value which are the following:

 

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

 

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

 

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

 

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**DEPOMED, INC.**

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

***(Unaudited)***

 

The adoption of FAS 157did not have a material impact on the Company’s financial position, results ofoperations or cash flows. In accordance with FAS 157, the following tablerepresents the Company’s fair value hierarchy for its financial assets measuredat fair value on a recurring basis as of June 30, 2009 (in thousands):

 
| ** **                             | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds                     |       | $           | 2,388      |        | $          | —      |       | $         | —     |   | $ | 2,388 |   |
| Commercial paper                       |       | —      |       | 10,190      |       | —      |       | 10,190    |       |
| U.S. corporate debt securities         |       | —      |       | 19,043      |       | —      |       | 19,043    |       |
| U.S. government agency debt securities |       | —      |       | 46,011      |       | —      |       | 46,011    |       |
| U.S. treasury securities               |       | —      |       | 3,083       |       | —      |       | 3,083     |       |
| Total                                  |       | $           | 2,388      |        | $          | 78,327      |       | $         | —     |   | $ | 80,715 |   |

 

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

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

 

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

 

**NOTE3.  NET LOSS PER COMMON SHARE**

 

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

 
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                         | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Weighted-average shares -  basic   |       | 51,263,620                           |       | 48,041,855                         |       | 51,235,735 |   | 47,954,052 |   |
| Effect of dilutive  securities:    |       |                                 |       |                               |       |   |   |   |   |
| Stock options                      |       | —                               |       | 357,476                            |       | — |   | — |   |
| Warrants                           |       | —                               |       | 6,002                              |       | — |   | — |   |
| Weighted-average shares -  diluted |       | 51,263,620                           |       | 48,405,333                         |       | 51,235,735 |   | 47,954,052 |   |

 

For the three and six months ended June 30,2009, approximately 6.6 million common stock equivalent shares are not includedbecause their effect is anti-dilutive. For the three and six months ended June 30,2008, approximately 6.5 million and 8.4 million common stock equivalent sharesare not included because their effect is anti-dilutive.

 

**NOTE 4. LICENSE AND COLLABORATIVEARRANGEMENTS**

 

***Solvay Pharmaceuticals, Inc.***

 

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

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

Pursuant to the agreement,Solvay Pharmaceuticals paid the Company a $25.0 million upfront fee in February 2009.The Company is also eligible to receive milestone payments for acceptance andFDA approval of the New Drug Application for DM-1796 for post-herpeticneuralgia (PHN), and sales milestone payments upon reaching certain salesmilestones. Solvay will pay the Company royalties of 14 to 20 percent of netproduct sales, depending on the level of product sales.

 

The Company will remainresponsible for completion of the ongoing Phase 3 clinical trial for DM-1796 inPHN, which was completely enrolled in June 2009, and will be responsiblefor certain other regulatory support activities through NDA approval. Solvaywill be responsible for the 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 agreementwill expire with the last to expire of the Company’s patents covering DM-1796,subject to early termination in certain circumstances.

 

The Company will beresponsible for the manufacture of DM-1796 for up to four years from theeffective date of the license agreement, pursuant to a supply agreement to beentered into by Depomed and Solvay by the end of 2009.

 

The Company isrecognizing the $25.0 million upfront payment ratably over the period of theCompany’s development and supply obligations under the agreement which isestimated to be through January 2013. For the three and six months endedJune, 2009, the Company recognized $1.5 million and $3.0 million, respectively,in license revenue under the arrangement. The remaining deferred revenuebalance is $22.0 million as of June 30, 2009.

 

***Covidien, Ltd.***

 

In November 2008,the Company entered into a license agreement with Mallinckrodt, Inc., asubsidiary of Covidien, Ltd. (Covidien) granting Covidien worldwide rights toutilize the Company’s Acuform® technology for the exclusive development of fourproducts containing acetaminophen in combination with opiates. 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 beingaccounted for as a single unit of accounting and being amortized ratablythrough November 2011, which is the length of time Depomed is obligated toperform formulation work under the agreement. For the three and six monthsended June 30, 2009, the Company recognized $0.5 million and $0.9 millionrespectively in license revenue under the agreement. The remaining deferredrevenue balance is $4.4 million as of June 30, 2009.

 

***Santarus, Inc.***

 

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

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

Santarus began promotion of GLUMETZA in October 2008. Santarus isrequired to meet certain minimum promotion obligations during the term of theagreement, and is required to make certain minimum marketing, advertising,medical affairs and other commercial support expenditures. The Companycontinues to record revenue from the sales of GLUMETZA product, and starting inOctober 2008, began paying Santarus a promotion fee equal to 80% of thegross margin earned from net sales of GLUMETZA product in the United States. Thepromotion fee will be reduced to 75% of gross margin beginning in the thirdquarter of 2010. For the three and six months ended June 30, 2009, theCompany recognized $5.6 million and $10.2 million, respectively, in promotionfee expense under the agreement, which is classified within selling, generaland administrative expense.

 

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

 

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

 

The Company is recognizing the $12.0 million upfront payment ratablyuntil October 2021, which represents the estimated length of time theCompany’s obligations exist under the arrangement for promotion fees it isobligated to pay Santarus.  For the threeand six months ended June 30, 2009, the Company recognized $0.2 millionand $0.5 million respectively in license revenue related to the amortization ofthe upfront payment. The remaining deferred revenue balance is $11.1 million asof June 30, 2009.

 

***WatsonPharma, Inc.***

 

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

 

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

 

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

 

The Company also receives ongoing royaltypayments from Teva on sales by Teva (including IVAX) of generic Glucophage XRin the United States, which is calculated as a percentage of sales, as reportedby a third-party market research company.  The royalty is subject to a $2.5million aggregate cap.  For the three andsix months ended June 30, 2009, the Company recognized $0.5 and $0.9million in royalty revenue related to this arrangement, respectively.  As of June 30, 2009, a cumulative totalof $2.1 million in royalties has been recognized to date, with $0.4 millionremaining under the aggregate cap.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

**NOTE5.  LONG-TERM DEBT**

 

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

 

The Company paid interest on the firsttranche for the first six months at an interest rate of 11.59%.  Beginning in January 2009, the Companyis required to pay the principal on the first tranche, plus interest at suchrate, in 30 equal monthly installments. The second tranche was interest-onlythrough December 31, 2008, with principal and interest payable thereafterin 30 equal monthly installments at an interest rate of 11.59%. Interestexpense, which includes amortization of debt issuance costs, was $0.3 millionand $0.5 million for the three and six months ended June 30, 2009,respectively.

 

As of June 30, 2009, the outstandingbalance under the facility was $7.8 million, and the unamortized portion of thedebt issuance costs was $0.2 million. Future contractual principal and interestpayments are as follows (in thousands):

 

| ** **                                              | ** ** | **Principal** | ** ** | **Interest** | ** ** |
|---------------------------------------------------------|------------|---------------|------------|--------------|------------|
| Less than 1 year (July 2009 — June 2010) |       | $             | 3,626      |         | $          | 731 |   |
| 1-2 years (July 2010 — June 2011)        |       | 4,075         |       | 282          |       |
| More than 2 years (July 2011 and thereafter)       |       | 145           |       | 1            |       |
| Total                                                   |       | $             | 7,846      |         | $          | 1,014 |   |

 

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

 

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

 

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

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

**NOTE6.  STOCK-BASED COMPENSATION**

 

The following table presents stock-basedcompensation expense recognized under FAS 123(R) for stock options, stockawards and the Company’s employee stock purchase program (ESPP) in the Company’sstatements of operations (in thousands):

 
| ** **                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                         |       |                                 |       |                               |       |   |   |   |   |
| Cost of sales                                |       | $                                    | 7          |                               | $          | 5 |   | $ | 16 |   | $ | 10 |   |
| Research and development  expense            |       | 228                                  |       | 181                                |       | 436 |   | 382 |   |
| Selling, general and  administrative expense |       | 424                                  |       | 415                                |       | 901 |   | 830 |   |
| Total                                        |       | $                                    | 659        |                               | $          | 601 |   | $ | 1,353 |   | $ | 1,222 |   |

 

At June 30, 2009, the Company had $3.9 million oftotal unrecognized compensation expense, net of estimated forfeitures, relatedto stock option grants that will be recognized over an average vesting periodof 1.9 years.

 

**NOTE7.  COMPREHENSIVE INCOME (LOSS)**

 

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

 
| ** **                                               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                               | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income (loss)                                        |       | $                                    | (9,615     | )                                  | $          | 3,480 |   | $ | (19,770 | ) | $ | (3,801 | ) |
| Unrealized gain (loss) on  available-for-sale securities |       | 37                                   |       | (73                                | )          | (29 | ) | (39 | ) |
| Total comprehensive income (loss)                        |       | $                                    | (9,578     | )                                  | $          | 3,407 |   | $ | (19,799 | ) | $ | (3,840 | ) |

 

**NOTE8.  INVENTORIES**

 

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

 

| ** **      | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|-----------------|------------|------------------------|------------|----------------------------|------------|
| Raw materials   |       | $                      | 169        |                       | $          | 266 |   |
| Work-in-process |       | —                 |       | 127                        |       |
| Finished goods  |       | 2,134                  |       | 2,392                      |       |
| Deferred costs  |       | 63                     |       | 64                         |       |
| Total           |       | $                      | 2,366      |                       | $          | 2,849 |   |

 

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

 

**NOTE9.  SHAREHOLDERS’ EQUITY**

 

***Option Exercises***

 

Forthe three and six months ended June 30, 2009, employees and consultantsexercised options to purchase 3,001 and 16,334 shares of the Company’s commonstock with net proceeds to the Company of approximately $6,000 and $32,000.

 

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**DEPOMED, INC.**

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

***(Unaudited)***

* *

***Employee Stock Purchase Plan***

 

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

 

**NOTE 10. RELATED PARTY TRANSACTIONS**

 

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

 

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

 

During the period of his consultancy, Dr. Fara will continue to vestin all of his currently unvested stock options, and his vested stock optionswill remain exercisable. For the three and six months ended June 30, 2009,the Company recognized approximately $7,500 and $12,000 in stock compensationexpense associated with these awards. In the event of a change in control ofthe Company, as defined by the Company’s 2004 Equity Incentive Plan, all of Dr. Fara’sunvested options will fully vest.

 

**NOTE 11.INCOME TAXES**

 

As of December 31,2008 and June 30, 2009, the Company had $2.8 million and $2.9 million ofunrecognized tax benefits, which is netted against deferred tax assets and isfully offset by a valuation allowance. All tax years since inception remain open to examination by the InternalRevenue Service and the California Franchise Tax Board until such time theCompany’s net operating losses and credits are either utilized or expire.Interest and penalties, if any, related to unrecognized tax benefits, would berecognized as income tax expense by the Company. The Company does not have anyaccrued interest or penalties associated with unrecognized tax benefits.  The Company does not foresee any materialchanges to unrecognized tax benefits within the next twelve months.

 

**NOTE 12.SUBSEQUENT EVENTS**

 

Weevaluated our subsequent events through August 7, 2009 when the financialstatements were issued.

 

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

 

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

 

Under terms of theagreement, Merck received a non-exclusive license as well as other rights tocertain Depomed patents directed to metformin extended release technology.  In exchange, the Company will receive a $10.0million upfront fee in the third quarter of 2009. The Company is also eligibleto receive a milestone payment upon filing of the New Drug Application for thetherapeutic candidate, as well as modest royalties on any net product sales foran agreed-upon period.  Merck will alsobe granted a right of reference to the New Drug Application covering theCompany’s GLUMETZA product in Merck’s regulatory filings covering fixed dosecombinations of sitagliptin and extended release metformin. The Company has nodevelopment obligations under the agreement.

 

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

 

### **FORWARD-LOOKINGINFORMATION**

### ** **

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

 

·                  resultsand timing of our clinical trials, including the results of our DM-1796 andSeradaTM trials;

 

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

 

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

 

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

 

·                  theresults of our internal research and development efforts;

 

·                  acceptanceand approval of regulatory filings;

 

·                  ourneed for, and ability to raise additional capital;

 

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

 

·                  ourplans to develop other product candidates.

 

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

 

**ABOUT DEPOMED**

 

Depomed is a specialtypharmaceutical company focused on the development and commercialization ofdifferentiated products that address large and growing markets and are based onproprietary oral drug delivery technologies. We have two product candidates in Phase 3 clinical trials.  In March 2008, we initiated a Phase 3clinical trial for DM-1796, an extended release formulation of gabapentin forthe treatment of postherpetic neuralgia that we have licensed to Solvay. In June 2009,we completed enrollment in our DM-1796 Phase 3 clinical trial. In September andOctober 2008, we initiated Breeze 1 and Breeze 2, our Phase 3 clinicaltrials for Serada, an extended release formulation of gabapentin for thetreatment of menopausal hot flashes.  In February 2009,we completed enrollment of our Breeze 1 trial, and in March 2009 wecompleted enrollment in our Breeze 2 trial for Serada. We expect to reportresults of all three Phase 3 trials early in the fourth quarter of 2009.

 

We seek to optimize theuse and value of our product candidates and drug delivery technologies in threeways.  First, we are seeking to assemblea number of pharmaceutical products that can be highly differentiated fromimmediate release versions of the compounds upon which they are based and maybe promoted together to women’s health care providers.  Our development of Serada, and our retentionof co-promotion rights within the obstetrics/gynecology field in ourcommercialization arrangements with Covidien, Ltd. and Santarus, Inc., areexamples of this aspect of our business strategy.  Second, we out-license product candidatesafter we have increased their value through our formulation and clinical developmentefforts.  Our DM-1796 license anddevelopment arrangement with Solvay Pharmaceuticals is an example of thisstrategy.  Third, we enter intocollaborative partnerships with other companies where the unique capabilitiesof our technology can provide superior value to a partner’s product candidate,resulting in greater value for Depomed than traditional fee-for-servicearrangements.  Our license anddevelopment arrangement with Covidien, Ltd. and our license agreement withMerck & Co., Inc. are examples of this strategy.

 

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

 

The following tablesummarizes our product pipeline and marketed products.

 

**Product Pipeline**

 
| 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 completed.                                                                      |

 

**Marketed Products**

 
| **Product**           | ** ** | **Indication**                         | ** ** | **Status**                                                                                                                                                                          |
|-----------------------|------------|----------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **            | ** ** | ** **                             | ** ** | ** **                                                                                                                                                                          |
| GLUMETZA®        |       | Type  2 diabetes                       |       | Currently  sold in the United States, Canada and Korea.*Co-promoted in the United States with Santarus.**Canadian rights held by Biovail.  Korean rights held by LG Life Sciences.* |
|                  |       |                                   |       |                                                                                                                                                                                |
| Proquin® XR |       | Uncomplicated  urinary tract infection |       | Currently  sold in the United States.  Regulatory application approved in Sweden. *European rights held by Rottapharm/Madaus.*                                                      |

 

Our intellectual propertyposition includes twelve issued patents and fifteen patent applications pendingin the United States.

 

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

 

·                  In June 2009, we completedenrollment of our Phase 3 clinical trial for DM-1796 for the treatment of postherpetic neuralgia.

 

·                  In May 2009, Shay Weisbrich wasappointed as our Vice President, Marketing.

 

·                  Revenue for the three months ended June 30,2009 was $11.6 million, compared to $6.3 million for the three months ended June 30,2008.

 

·                  Operating expenses for the threemonths ended June 30, 2009 were $20.0 million, compared to $2.4 millionfor the three months ended June 30, 2008. Operating expenses for the threemonths ended June 30, 2008 included a one-time gain of $7.5 million onlitigation related to the IVAX settlement, which had the effect of reducingoperating expenses for the quarter.

 

·                  Cash, cash equivalents and marketablesecurities were $84.0 million as of June 30, 2009, compared to $82.1million as of December 31, 2008.

 

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**RECENT PRODUCT DEVELOPMENTS AND TRANSACTIONS**

 

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

## * *

*Phase 3Registration Program. * Our Phase 3 registration program for Serada inmenopausal hot flashes includes two randomized, double-blind, placebo-controlledstudies of approximately 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, patientswill 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 secondary endpoints.The treatment duration in the second study, Breeze 2, will be three months,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 thestudies will be available in the fourth quarter of 2009.

 

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

## * *

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

 

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

 

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

 

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

 

*Phase 3Registration Program. * In March 2008, we initiated dosing of thefirst patient in a second Phase 3 clinical trial for DM-1796 for PHN.  The study is a randomized, double-blind,placebo-controlled study of approximately 450 PHN patients.  Patients in the study are randomized into twotreatment arms:  placebo, or 1800mg ofDM-1796 dosed once daily. The study is being conducted at sites in the UnitedStates, Russia and Argentina. In June 2009, the study was fully enrolled.

 

The primary objective of the study is to assess theefficacy of DM-1796 in reducing the pain associated with PHN, measured 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 preliminary top-line results from the study will be availablein the fourth quarter of 2009.

 

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***DM-1992 for Parkinson’s Disease***

 

In July 2008, The Michael J. Fox Foundationawarded the Company a preclinical development grant to support the DM-1992program. DM-1992 is our investigative novel gastric retentive extended-releaseformulation of levodopa/carbidopa.  InJanuary 2009, we initiated a Phase 1 pharmacokinetic study in Parkinson’spatients designed to provide us with insight into our formulation strategy forthe DM-1992 program.  In August 2009, wecompleted the study.  In the study,DM-1992 extended coverage above levodopa’s efficacious threshold and extendedthe time to peak levodopa concentration relative to currently availablesustained release levodopa/carbidopa formulations.  One of our formulations tested in the studyextended the median time at which levodopa blood levels fell below theefficacious threshold of 300 ng/mL to approximately nine hours, compared toapproximately seven hours for the generic version of Sinemet CR tested in thestudy.  The time to median peak levodopablood levels in the study was extended to four hours, compared to 2.8 hours forthe comparator.  DM-1992 was welltolerated in the study.  

 

The Phase I trial in DM-1992 was a randomized,open-label crossover study that enrolled 18 patients with stable Parkinson’sdisease at two leading neurology centers in Russia.  The objective of the study was to compare thepharmacokinetics of two distinct formulations of DM-1992 and a generic versionof Sinemet CR sustained-release levodopa/carbidopa, as well as the safety andtolerability of the formulations. Patients in the trial received a single dose of each of the three treatmentsbeing studied.  A dose of the firsttreatment was administered at the beginning of the study, followed by a dose ofa second treatment after 7 to 14 days, and a dose of the third treatment afteranother 7 to 14 days.  Blood samples weredrawn during the 24 hour period following administration of eachtreatment.  Patients remained on anyanti-Parkinson’s therapy other than levodopa/carbidopa during the trial.

 

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

 

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

 

Under terms of theagreement, Merck will receive a non-exclusive license as well as other rightsto certain our patents directed to metformin extended release technology. Inexchange, we will receive a $10.0 million upfront fee in the third quarter of2009. We are also eligible to receive a milestone payment upon filing of theNew Drug Application for the therapeutic candidate, as well as modest royaltieson any net product sales for an agreed-upon period.  Merck will also be granted a right ofreference to the New Drug Application covering our GLUMETZA product in Merck’sregulatory filings covering fixed dose combinations of sitagliptin and extendedrelease metformin. We have no development obligations under the agreement.

 

***Proquin******®****** XR***

 

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

 

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

 

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

 

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

 

**CRITICAL ACCOUNTING POLICIES**

 

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

 

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### **RESULTS OF OPERATIONS**

### ** **

*Three and SixMonths Ended June 30, 2009 and 2008*

### ** **

### **Revenue**

### ** **

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

 
| ** **              | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Product sales:          |       |                                 |       |                               |       |   |   |   |   |
| GLUMETZA                |       | $                                    | 8,245      |                               | $          | 5,405 |   | $ | 14,888 |   | $ | 10,571 |   |
| Proquin XR              |       | 163                                  |       | 114                                |       | 360 |   | 174 |   |
| Total product sales     |       | 8,408                                |       | 5,519                              |       | 15,248 |   | 10,745 |   |
|                    |       |                                 |       |                               |       |   |   |   |   |
| Royalties:              |       |                                 |       |                               |       |   |   |   |   |
| GLUMETZA                |       | 65                                   |       | 72                                 |       | 101 |   | 184 |   |
| Teva                    |       | 464                                  |       | 361                                |       | 892 |   | 361 |   |
| Total royalties         |       | 529                                  |       | 433                                |       | 993 |   | 545 |   |
|                    |       |                                 |       |                               |       |   |   |   |   |
| License revenue:        |       |                                 |       |                               |       |   |   |   |   |
| DM-1796                 |       | 1,561                                |       | —                             |       | 3,038 |   | — |   |
| GLUMETZA                |       | 626                                  |       | 363                                |       | 1,252 |   | 727 |   |
| AcuForm technology |       | 458                                  |       | —                             |       | 916 |   | — |   |
| Proquin XR              |       | 26                                   |       | —                             |       | 33 |   | — |   |
| Total license revenue   |       | 2,671                                |       | 363                                |       | 5,239 |   | 727 |   |
|                    |       |                                 |       |                               |       |   |   |   |   |
| Total revenues          |       | $                                    | 11,608     |                               | $          | 6,315 |   | $ | 21,480 |   | $ | 12,017 |   |

 

***Productsales***

 

*GLUMETZA.*The increase inGLUMETZA product sales in the three and six months ended June 30, 2009 ascompared to the three and six months ended June 30, 2008 is primarilyattributable to price increases of the 500mg GLUMETZA, the introduction of the1000mg GLUMETZA in June 2008 and the promotional efforts of Santarus.

 

Beginning inthe third quarter of 2008, we began to recognize GLUMETZA product saleswhen title transfers to our customer, which is at the time our customerreceives the product shipment, and we provide for an estimate of future productreturns at that time. Prior to the third quarter of 2008, we were unable toreasonably estimate expected returns of the product at the time of shipment,and therefore, deferred revenue on product shipments until the product wasdispensed through patient prescriptions.

 

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

 

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

 

The increase in Proquin XR product sales for the threeand six months ended June 30, 2009 as compared to the three and six monthsended June 30, 2008 is primarily due to a longer period of time 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 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 affiliates IVAXCorporation 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 and six months ended June 30, 2009, we recognized$0.5 million and $0.9 million, respectively, in royalty revenue related to thisarrangement. As of June 30, 2009, a cumulative total of $2.1 million inroyalties has been recognized to date, with $0.4 million remaining under theaggregate cap.

 

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

 

***Licenserevenue***

 

*DM-1796.*DM-1796 licenserevenue for the three and six months ended June 30, 2009 relates to the$25.0 million 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 and six months ended June 30, 2009 consisted oflicense revenue recognized from the $25.0 million upfront license fee receivedfrom Biovail in July 2005 and the $12.0 million upfront fee received fromSantarus in July 2008.  Licenserevenue for the three and six months ended June 30, 2008 consisted solelyof license revenue recognized from the $25.0 million upfront license feereceived from Biovail.

 

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

 

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

 

**Cost of Sales**

 

Cost of sales consists of costs of the active pharmaceuticalingredient, contract manufacturing and packaging costs, inventory write-downs,product quality testing, internal employee costs related to the manufacturingprocess, distribution costs and shipping costs related to our product sales.Total cost of sales for the three and six months ended June 30, 2009, ascompared to the prior year, was as follows (in thousands):

 
| ** **    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **    | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost of sales |       | $                                    | 1,229      |                               | $          | 962 |   | $ | 2,261 |   | $ | 2,171 |   |
|               |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

Cost of sales for the three and six months ended June 30,2009 and 2008 relate primarily to costs associated with the sale of GLUMETZAand Proquin XR. Cost of sales increased in 2009 over 2008 primarily as a resultof an increase in GLUMETZA product sales and the introduction of the 1000mgGLUMETZA in June 2008.

 

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

 

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**Researchand Development Expense**

 

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

 

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

 
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                         | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Research and development  expense  |       | $                                    | 10,024     |                               | $          | 4,680 |   | $ | 20,045 |   | $ | 10,750 |   |
| Dollar change from prior  year     |       | 5,344                                |       |                               |       | 9,295 |   |   |   |
| Percentage change from  prior year |       | 114.2                                | %          |                               |       | 86.5 | % |   |   |
|                                    |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

The increase in research and development expense forthe three and six months ended June 30, 2009 as compared to the three andsix months ended June 30, 2008 was primarily due to higher clinicalresearch organization expenses related to our two Phase 3 clinical trials forSerada for the treatment of menopausal hot flashes, which started in September 2008.In February 2009, we completed enrollment of our Breeze 1 Phase 3 clinicaltrial for Serada. In March 2009, we completed enrollment of our Breeze 2Phase 3 clinical trial for Serada. The treatment duration of the Breeze 1 studyis six months, and the treatment duration of the Breeze 2 study is threemonths.

 

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

 

Because we expect these three ongoing Phase 3 clinicaltrials to be completed in 2009, we expect research and development expense todecrease in the second half of 2009 relative to the first half of 2009.

 

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

 
| ** **                               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(In thousands)**                       | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| DM-1796                                  |       | $                                    | 2,645      |                               | $          | 3,222 |   | $ | 6,726 |   | $ | 7,188 |   |
| Serada                                   |       | 5,279                                |       | 824                                |       | 8,854 |   | 2,240 |   |
| Other projects                           |       | 2,100                                |       | 634                                |       | 4,465 |   | 1,322 |   |
| Total research and  development expenses |       | $                                    | 10,024     |                               | $          | 4,680 |   | $ | 20,045 |   | $ | 10,750 |   |

 

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**Selling, General and AdministrativeExpense**

 

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

 
| ** **                           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Selling, general and  administrative |       | $                                    | 9,945      |                               | $          | 5,241 |   | $ | 18,947 |   | $ | 11,748 |   |
| Dollar change from prior  year       |       | 4,704                                |       |                               |       | 7,199 |   |   |   |
| Percentage change from  prior year   |       | 89.8                                 | %          |                               |       | 61.3 | % |   |   |
|                                      |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

The increase in selling,general and administrative expense in 2009 as compared to 2008 was primarilydue to $5.6 million and $10.2 million in GLUMETZA promotion fee expense underour promotion agreement with Santarus for the three and six months ended June 30,2009, respectively. Santarus began promotion of GLUMETZA in October 2008.Those increases are partially offset by decreases in other sales and marketingexpenses for GLUMETZA in 2009, as a majority of those efforts have beentransferred to Santarus, as well as a decrease in legal expenses in 2009resulting from our litigation settlement with IVAX in April 2008.

 

**Gain on Litigation Settlement**

 

InApril 2008, we entered into a settlement and license agreement with Tevarelated to the patent infringement lawsuit filed by us against Teva affiliatesIVAX Corporation and IVAX Pharmaceuticals, Inc. The settlement agreementprovided for a one-time payment to us of $7.5 million, which we received in April 2008,and for a non-exclusive license in favor of Teva (including IVAX) to continueto market its generic Glucophage XR product in the United States.  We recognized the $7.5 million one-timepayment received as a gain on litigation within operating income during thesecond quarter of 2008.

 

**Interest Income and Expense**

 
| ** **                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(in thousands)**             | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest and other income      |       | $                                    | 236        |                               | $          | 553 |   | $ | 550 |   | $ | 1,356 |   |
| Interest expense               |       | (263                                 | )          | (5                                 | )          | (548 | ) | (5 | ) |
| Net interest income  (expense) |       | (27                                  | )          | 548                                |       | 2 |   | 1,351 |   |
|                                |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

Interest and other income decreased during the three and six monthsended June 30, 2009 as compared to the corresponding period in 2008 as aresult of lower interest rates on our investments.

 

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

 

**LIQUIDITYAND CAPITAL RESOURCES**

** **

| **(in thousands)**                                | ** ** | **June 30,********2009** | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| Cash, cash equivalents and  marketable securities |       | $                             | 83,981     |                        | $          | 82,059 |   |
|                                                   |            |                               |            |                             |            |  |  |

 

InFebruary 2009, we received a $25.0 million upfront payment from Solvayrelated to our license agreement for DM-1796.

 

Sinceinception through June 30, 2009, we have financed our product developmentefforts and operations primarily from private and public sales of equitysecurities and from license and termination fees from collaborative and licensepartners.

 

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

 

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

 

We paid interest only on the first tranchefor the first six months at an interest rate of 11.59%.  Thereafter we are required to pay principalon the first tranche, plus interest at such rate, in 30 equal monthly installments.The second tranche was interest-only through December 31, 2008, withprincipal and interest payable thereafter in 30 equal monthly installments withan interest rate of 11.59%. As of June 30, 2009, the entire outstanding balance onthe credit facility was $7.8 million at an interest rate of 11.59%.

 

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

 

Asof June 30, 2009, we have accumulated net losses of $170.0 million. Weexpect to continue to incur operating losses for the remainder of 2009. Weanticipate that our existing capital resources will permit us to meet ourcapital and operational requirements through at least the end of 2010. We basethis expectation on our current operating plan, which may change as aresult of many factors.

 

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

 

·          sales of our marketed products;

 

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

 

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

 

·          results of research and development efforts;

 

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

 

·          technological advances;

 

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

 

·          acquisitions or investment in complimentarybusinesses, products or technologies.

 

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

 

·          conduct research and development programs;

 

·          commercialize any products we market;

 

·          conduct preclinical and clinical testing; and

 

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

 

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

 

·          delay, postpone or terminate clinical trials;

 

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

 

·          obtain funds through entering intocollaboration agreements on unattractive terms.

 

The inability to raise additionalcapital required to fund our operations would have a material adverse effect onour company.

 

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### **Cash Flows from OperatingActivities**

### ** **

Cash provided by operating activities during the sixmonths ended June 30, 2009 was approximately $3.5 million, compared tocash used in operating activities of approximately $1.7 million for the sixmonths ended June 30, 2008.  Theincrease in cash provided by operating activities for the six months ended June 30,2009 as compared to cash used in operating activities six months ended June 30,2008 was primarily due to an increase in deferred revenue as a result of thereceipt of the $25.0 million upfront payment from Solvay in February 2009offset by an increase in net loss for the six months ended June 30, 2009.

 

**Cash Flows from Investing Activities**

 

Net cash used in investing activities during the sixmonths ended June 30, 2009 was approximately $16.2 million and consistedprimarily of a net increase in marketable securities resulting from investmentof the upfront payment received from Solvay in February 2009. Net cashprovided by investing activities during the six months ended June 30, 2008was approximately $32.6 million and consisted primarily of proceeds from thematurity/sale of marketable securities.

 

**Cash Flows from Financing Activities**

 

Cash used infinancing activities during the six months ended June 30,2009 was approximately $1.4 million compared tocash provided by financing activities of approximately $3.7 million for thesame period in 2008. For the six months ended June 30, 2009, cash used in financing activities primarily consistedof repayments of principal on our credit facility. For the six monthsended June 30, 2008, cash provided byfinancing activities consisted of cash proceeds from exercises of stockoptions.

 

**Contractual Obligations**

 

As of June 30, 2009, our aggregate contractual obligations are asshown in the following table (in thousands):

 
| ** **                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Total** | ** ** |
|----------------------------|------------|-----------------------|------------|---------------|------------|---------------|------------|-----------|------------|
| Operating leases           |       | $                     | 1,609      |          | $          | 2,579         |       | $         | —     |   | $ | 4,188 |   |
| Long-term debt (principal) |       | 3,625                 |       | 4,221         |       | —        |       | 7,846     |       |
| Long-term debt (interest)  |       | 731                   |       | 283           |       | —        |       | 1,014     |       |
| Purchase commitments       |       | 1,850                 |       | —        |       | —        |       | 1,850     |       |
|                       |       | $                     | 7,815      |          | $          | 7,083         |       | $         | —     |   | $ | 14,898 |   |

 

At June 30, 2009,we had non-cancelable purchase orders and minimum purchase obligations ofapproximately $1.3 million under our manufacturing agreement with PatheonPuerto Rico, Inc. for the manufacture of the 500mg GLUMETZA and $0.5million under our supply agreement with Biovail for the supply of the 1000mgGLUMETZA. The amounts disclosed only represent minimum purchase requirements.Actual purchases are expected to exceed these amounts.

 

The contractualobligations reflected in this table exclude $3.0 million of contingentmilestone payments we may be obligated to pay in the future under oursublicense agreement with PharmaNova. These payments relate to variousmilestones for the product candidate under the sublicense agreement, includingdosing of the first patient in any Phase 3 trial, submission to the FDA of anNDA, and FDA approval of an NDA. The above table also excludes any futureroyalty payments we may be required to pay on products we have licensed or anypromotion fees associated with our promotion agreement with Santarus.

 

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

 

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

 

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**ITEM 4. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

An evaluation was performedunder the supervision and with the participation of our management, includingthe Company’s Chief Executive Officer and Vice President, Finance, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this quarterly report. Basedon that evaluation, our management, including the Company’s Chief ExecutiveOfficer and Vice President, Finance, concluded that our disclosure controls andprocedures were effective.

 

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

 

***Changes in Internal Controls***

 

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

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

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

 

In December 2007,Apotex, Inc. (Apotex) filed the Canadian equivalent of an Abbreviated 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 our Canadianlicense agreement with Biovail for GLUMETZA, Biovail has the first right toprosecute, and pay for expenses related to, any Canadian litigation related togeneric challenges to GLUMETZA.  In January 2008,Biovail filed suit against Apotex in Canada in response to Apotex’s regulatoryfiling, and we have been joined to the lawsuit as a co-plaintiff with Biovailbecause we are the licensor of the patents at issue in the suit.  The initiation of the lawsuit automaticallystays approval of Apotex’s formulation for 24 months. In October 2008, thecourt issued a ruling requiring that Apotex present its evidence in the case bymid-January 2009, and that Biovail present its evidence by mid-April 2009. Eachparty has presented its evidence in the case. Depositions of witnesses and experts in the case have occurred. Ahearing before an administrative law judge to determine the outcome of thematter is scheduled for November 2009. An adverse outcome in this matter couldsubstantially 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.

 

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

 

In January 2009, our exclusivelicense agreement with Solvay Pharmaceuticals Inc. related to the developmentandcommercialization of DM-1796 became effective. The license agreement grants Solvay exclusive rights to develop andcommercialize DM-1796 in the United States, Canada and Mexico for painindications.  We depend on Solvay toobtain regulatory approval and complete any further development of DM-1796,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;

 

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·                  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 safeand effective.  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.

 

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

 

If Serada is approved for marketing in the UnitedStates, we may choose to promote the product with our own sale force or througha contract sales organization. We also have rights to promote GLUMETZA throughour own sales force, or through third parties. We currently have no sales forceand limited marketing and sales staff. The success of our own promotion efforts for Serada, GLUMETZA and anyother product candidates that receive regulatory approval that we choose tomarket or co-market, will require that we substantially enhance our in-housemarketing and sales force with technical expertise, or make arrangements withthird parties to perform these services for us.  The development of the infrastructureassociated with these activities involves substantial resources, andconsiderable attention of our management and key personnel. To the extent thatwe enter into marketing and sales arrangements with other companies, ourrevenues will depend on the efforts of others. These efforts may not be successful.  If we fail to fully develop marketing andsales capabilities, or enter into arrangements with third parties, our revenuesmay suffer.

** **

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

 

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

 

·     Santarus may acquireor develop alternative products;

 

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

 

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

 

·     GLUMETZA may fail toachieve greater market acceptance; and

 

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

 

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

 

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

 

We have the following programs in clinicaldevelopment: DM-1796 for neuropathic pain and Serada for menopausal hotflashes. 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 in earliertrials may not be indicative of results that will be obtained in subsequentlarger trials, as was the case with the Phase 3 trial for DM-1796 for thetreatment of postherpetic neuralgia that we completed in 2007.

 

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

 

**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,AmerisourceBergen and McKesson, and we will depend on them to ensure that ourmarketed products are widely available. To continue to support our commercialization effort related to ourmarketed products, we must continue to enhance our internal commercialinfrastructure, and continue to contract with capable third parties to assistus in our commercialization efforts.  Thecontinued development of that infrastructure will also require substantialresources, which may divert the attention of our management and keypersonnel.  The efforts of third partieswith whom we contract for distribution of our products may not besuccessful.

 

**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.

 

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

 

We entered into a$15.0 million credit facility with Oxford Finance Corporation and GeneralElectric Capital Corporation in June 2008. We have drawn $9.4 million under the facility and will not make anyfurther draws under the facility. As of June 30, 2009, we have $7.8million of principal outstanding under the facility. The credit facility issecured by

 

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a pledge of all of our assets other than intellectualproperty, and contains a variety of operational covenants, includinglimitations on our ability to incur liens or additional debt, makedispositions, pay dividends, redeem our stock, make certain investments andengage in certain merger, consolidation or asset sale transactions andtransactions 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 or anyfuture debt financing will need to be repaid, which creates additional financialrisk for our company, particularly if our business, or prevailing financialmarket 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 we maybe able to generatesufficient 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.

 

**The global economic downturn may adversely affectour business.**

 

Some economists are nowpredicting that the United States economy, and possibly the global economy, mayenter into a prolonged downturn or recession as a result of recent economicevents, including the deterioration of the credit and capital markets andrelated financial crisis.  Though the ultimate effect of thesedevelopments cannot be predicted, they may have a material adverse effect onour liquidity and financial condition and our ability to raise additional funds,whether pursuant to our existing or future financing arrangements.  Inaddition, if these developments negatively impact the ability of ourcollaborative partners to develop, manufacture, promote or commercialize ourproducts and product candidates, our revenues may suffer and our business,financial condition and results of operations could be materially and adverselyaffected.  Similarly, any negative impact of an economic downturn orrecession on our potential collaborative partners could adversely affect theterms on which collaborative partnerships may be available to us, if at all.

 

**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 sixmonths ended June 30, 2009, we recorded total revenues of $21.5 millionand for the years ended December 31, 2008, 2007 and 2006, we recordedtotal revenues of $34.8 million, $65.6 million, and $9.6 million, respectively.For the six months ended June 30, 2009, we incurred a net loss of $19.8million 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;

 

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·                  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 arrangementsmay also limit or preclude us from developing products or technologiesdeveloped pursuant to such collaborations. Additionally, the collaboratorsunder these arrangements might breach the terms of their respective agreementsor fail to prevent infringement of the licensed patents by third parties.Moreover, negotiating collaborative arrangements often takes considerablylonger to conclude than the parties initially anticipate, which could cause usto enter into less favorable agreement terms that delay or defer recovery ofour development costs and reduce the funding available to support key programs.

 

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

 

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

 

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

 

·                  premature termination of acollaboration agreement; or

 

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

 

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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 future collaborativepartners may pursue existing or other development-stage products oralternative technologies in preference to those being developed incollaboration with us. Our collaborative partners may also terminate theircollaborative relationships with us or otherwise decide not to proceed withdevelopment and commercialization of our products.

 

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

 

Our success will depend in part on our ability to obtain and maintainpatent protection for our products and technologies, and to preserve our tradesecrets.  Our policy is to seek toprotect our proprietary rights, by, among other methods, filing patent applicationsin the 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.  If claimsconcerning any of our products were to arise and it was determined that theseproducts infringe a third party’s proprietary rights, we could be subject tosubstantial damages for past infringement or be forced to stop or delay ouractivities with respect to any infringing product, unless we can obtain alicense, or we may have to redesign our product so that it does not infringeupon others’ patent rights, which may not be possible or could requiresubstantial funds or time.  Such a license may not be available onacceptable terms, or at all.  Even if we, our collaborators or ourlicensors were able to obtain a license, the rights may be nonexclusive, whichwould give our competitors access to the same intellectual property.  Inaddition, any public announcements related to litigation or interferenceproceedings initiated or threatened against us, even if such claims are withoutmerit, could cause our stock price to decline.

 

From time to time, we may become aware of activities by third partiesthat may infringe our patents.  Infringement by others of our patents mayreduce our market shares (if a related product is approved) and, consequently,our potential future revenues and adversely affect our patent rights if we donot take appropriate enforcement action.  We may need to engage inlitigation in the future to enforce any patents issued or licensed to us or todetermine the scope and validity of third-party proprietary rights.  Ourissued or licensed patents may not be held valid by a court of 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.

 

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

 

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

 

**Itis difficult to develop a successful product. If we do not 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 thanGLUMETZA and Proquin XR, we, our current and any future collaborative partnerswill need to:

 

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

 

·                  obtain regulatory approval from the FDA or foreign regulatoryauthorities.

 

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

 

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

 

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

 

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

 

·                  market acceptance;

 

·                  cost-effective commercial scale production; and

 

·                  reimbursement under private or governmental health plans.

 

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

 

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

 

For planning purposes, wesometimes estimate the timing of the accomplishment of various scientific,clinical, regulatory and other product development and commercializationgoals.  These milestones may include ourexpectations regarding the commercial launch of our products by us or our licensees, and the commencement orcompletion of scientific studies and clinical trials and the submission ofregulatory filings.  From time to time,we may publicly announce the expected timing of some of these milestones, suchas the completion of an ongoing clinical trial, the initiation of otherclinical programs, or the commercial launch of products.  All of these milestones are based on avariety of assumptions.  The actualtiming of these milestones can vary considerably from our estimates dependingon numerous factors, some of which are beyond our control, including:

 

·                  our available capital resources;

 

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

 

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

 

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

 

·                  other actions by regulators;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Further, with respect to our approved products, onceregulatory approval is obtained, a marketed product and its manufacturer aresubject to continual review. The discovery of previously unknown problems witha product or manufacturer may result in restrictions on the product,manufacturer or manufacturing facility, including withdrawal of the productfrom 

 

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the market. Manufacturers of approved products are also subject toongoing regulation, including compliance with FDA regulations governing currentGood Manufacturing 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.

 

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.

 

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**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.), Johnson & Johnson, SkyePharma plc,Biovail Corporation, Flamel Technologies S.A., Ranbaxy Laboratories, Ltd., KosPharmaceuticals, Inc., Intec Pharma and Alpharma, Inc., all of whichdevelop oral tablet products designed to release the incorporated drugs overtime. Each of these companies has patented technologies with attributesdifferent from ours, and in some cases with different sites of delivery to thegastrointestinal 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 approvedfor marketing in the United States and the European Union.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Ourbusiness involves exposure to potential product liability risks that are inherentin the development and production of pharmaceutical products. We have obtainedproduct 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 againstpotential liabilities.

 

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

 

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

 

Oursuccess is dependent in large part upon the continued services of our Presidentand Chief Executive Officer, Carl A. Pelzel, and other members of our executivemanagement team, and on our ability to attract and retain key management andoperating personnel. We do not have agreements with Mr. Pelzel or any ofour other executive officers that provide for their continued employment withus. Our former Chairman, President and Chief Executive Officer retired in August 2007,and our Chief Financial Officer retired in October 2007; we 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 these acquisitionsor to successfully integrate them in a cost effective and non-disruptivemanner.**

 

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 know ifwe would be able to successfully complete any acquisitions, or whether we wouldbe 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-takeoverprovisions.**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

**Businessinterruptions could limit our ability to operate our business.**

 

Our operations arevulnerable to damage or interruption from computer viruses, human error,natural disasters, telecommunications failures, intentional acts of vandalismand similar events. In particular, our corporate headquarters are located inthe San Francisco Bay area, which has a history of seismic activity. We havenot established a formal disaster 

 

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recovery plan, and our back-up operations andour business interruption insurance may not be adequate to compensate us forlosses that occur. A significant business interruption could result in lossesor damages incurred by us and require us to cease or curtail our operations.

 

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

 

Not applicable.

 

**ITEM 3.      DEFAULTSUPON SENIOR SECURITIES**

 

Not applicable.

 

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

 

The Company held its annualmeeting of shareholders on May 14, 2009 to consider and vote on thefollowing proposals: (i) the election of directors until the next annualmeeting of shareholders (Proposal 1); and (ii) the ratification of Ernst &Young LLP as the independent registered public accounting firm of the Companyfor the fiscal year ending December 31, 2009 (Proposal 2).

 

Proposal 1:   Theshareholders of Depomed elected eight directors to serve until the next annualmeeting of shareholders.  The votesregarding the election of directors were as follows:

 

| ** **              | ** ** | **Shares Voted For** | ** ** | **Votes Withheld** | ** ** |
|-------------------------|------------|----------------------|------------|--------------------|------------|
| Peter D. Staple         |       | 42,674,805           |       | 2,015,441          |       |
| G. Steven Burrill       |       | 42,420,436           |       | 2,269,810          |       |
| Karen A. Dawes          |       | 42,674,995           |       | 2,015,251          |       |
| Carl A. Pelzel          |       | 40,401,242           |       | 4,289,004          |       |
| James A. Schoeneck      |       | 42,674,505           |       | 2,015,741          |       |
| Craig R. Smith, M.D     |       | 33,118,379           |       | 11,571,867         |       |
| Julian N. Stern         |       | 32,299,306           |       | 12,390,940         |       |
| David B. Zenoff, D.B.A. |       | 42,673,925           |       | 2,016,321          |       |

 

Proposal 2:  Theshareholders of Depomed approved the appointment of Ernst & Young LLPas the independent registered public accounting firm of the Company for thefiscal year ending December 31, 2009 with the following votes:

 

| For     |   | 44,091,262 |   |
|---------|--------|------------|--------|
| Against |   | 246,422    |   |
| Abstain |   | 352,562    |   |

 

**ITEM5.      OTHER INFORMATION**

 

Not applicable.

 

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**ITEM 6.EXHIBITS**

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

 

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##### **SIGNATURES**

##### ** **

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

 

 
| Date:  August 7, 2009 | DEPOMED, INC.                   |
|----------------------------|--------------------------------------|
|                       |                                 |
|                       |                                 |
|                       | /s/ Carl A.  Pelzel                  |
|                       | Carl A. Pelzel                       |
|                       | President andChief Executive Officer |
|                       |                                 |
|                       |                                 |
|                       | /s/ Tammy L.  Cameron                |
|                       | Tammy L. Cameron                     |
|                       | Vice President,  Finance             |

 

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