<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____ TO ____
COMMISSION FILE NUMBER 000-23267
DEPOMED, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-3229046
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
366 LAKESIDE DRIVE
FOSTER CITY, CALIFORNIA 94404
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(650) 513-0990
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
requirements for the past 90 days.
YES [X] NO [ ]
The number of issued and outstanding shares of the Registrant's Common
Stock, no par value, as of October 29, 1998, was 6,463,438.
<PAGE>
DEPOMED, INC.
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
PAGE
----
<S> <C>
Unaudited Condensed Balance Sheet at September 30, 1998...................................... 3
Unaudited Condensed Statements of Operations for the three month periods ended
September 30, 1998 and 1997, the nine month periods ended September 30, 1998
and 1997 and the period from inception (August 7, 1995) to September 30, 1998............ 4
Unaudited Condensed Statements of Cash Flows for the nine month periods ended
September 30, 1998 and 1997 and the period from inception (August 7, 1995) to
September 30, 1998....................................................................... 5
Notes to Unaudited Condensed Financial Statements............................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................. 9
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.............................................. 19
Item 6. Exhibits and Reports on Form 8-K....................................................... 20
Signature...................................................................................... 21
</TABLE>
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<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED BALANCE SHEET
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
----
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,282,918
Short-term investments 1,005,670
Accounts receivable 217,687
Other current assets 67,222
-----------
Total current assets 7,573,497
Property and equipment, net 766,238
Long-term investments 2,026,280
Other assets 32,236
-----------
$10,398,251
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 138,861
Accrued compensation 68,285
Capital lease obligation, current portion 53,483
-----------
Total current liabilities 260,629
Capital lease obligation, non-current portion 82,977
Commitments
Shareholders' equity:
Common stock 14,514,224
Deferred compensation (438,420)
Unrealized gain or loss on securities 13,687
Deficit accumulated during the development stage (4,034,846)
-----------
Total shareholders' equity 10,054,645
-----------
$10,398,251
===========
</TABLE>
See accompanying notes to Unaudited Condensed Financial Statements.
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<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------ ------------------- INCEPTION
SEPTEMBER 30, SEPTEMBER 30, (AUGUST 7, 1995)
------------- ------------- TO
1998 1997 1998 1997 SEPTEMBER 30, 1998
---- ---- ---- ---- -------------------
<S> <C> <C> <C> <C> <C>
Product development revenue $ 217,687 $ 104,454 $ 456,990 $ 456,191 $ 1,379,837
Operating expenses:
Research and development 573,673 244,778 1,412,987 573,381 2,795,424
General and administrative 416,341 219,095 1,138,191 649,838 2,647,082
Purchase of in-process
research and development - - - - 298,154
---------- ---------- ----------- ---------- -----------
Total operating expenses 990,014 463,873 2,551,178 1,223,219 5,740,660
Loss from operations (772,327) (359,419) (2,094,188) (767,028) (4,360,823)
Interest income (expense), net 126,831 (17,269) 369,234 (37,379) 325,976
---------- ---------- ----------- ---------- -----------
Net loss $ (645,496) $ (376,688) $(1,724,954) $ (804,407) $(4,034,847)
========== ========== =========== ========== ===========
Basic and diluted net loss per
share $ (0.10) $ (0.11) $ (0.28) $ (0.24)
---------- ---------- ----------- ----------
Shares used in computing
basic and diluted net loss
per share 6,463,438 3,354,825 6,269,299 3,354,825
========== ========== =========== ==========
</TABLE>
See accompanying notes to Unaudited Condensed Financial Statements.
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<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
----------------- INCEPTION
SEPTEMBER 30, (AUGUST 7, 1995)
------------- TO
1998 1997 SEPTEMBER 30, 1998
---- ---- -------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,724,954) $ (804,407) $(4,034,847)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 139,130 42,173 241,146
Accrued interest expense on notes - 40,654 13,618
Amortization of deferred compensation expense 140,695 84,961 257,031
Purchase of in-process research and development - - 298,154
Changes in assets and liabilities:
Accounts receivable (72,800) (29,803) (217,687)
Other current assets 33,457 (893,787) (67,222)
Other assets (21,837) 4,320 (32,252)
Accounts payable (140,395) 510,157 138,861
Accrued compensation 32,738 44,202 809
Other current liabilities (74,086) (6,749) -
------------ ----------- -----------
Net cash used in operating activities (1,688,052) (1,008,279) (3,402,389)
------------ ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (589,515) (55,968) (727,524)
Purchases of investments (3,018,263) - (3,097,845)
Proceeds from sale of investments - - 79,582
------------ ----------- -----------
Net cash used in investing activities (3,607,778) (55,968) (3,745,787)
------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on capital lease obligations (42,951) (24,100) (143,442)
Proceeds from issuance of notes - 1,000,000 1,050,000
Payments of notes - - (1,000,000)
Payment of shareholder loans - - (294,238)
Proceeds from issuance of common stock 7,492,154 278,500 13,818,774
------------ ----------- -----------
Net cash provided by financing activities 7,449,203 1,254,400 13,431,094
------------ ----------- -----------
Net increase in cash and cash equivalents 2,153,373 190,153 6,282,918
Cash and cash equivalents at beginning of period 4,129,545 10,802 -
------------ ----------- -----------
Cash and cash equivalents at end of period $ 6,282,918 $ 200,955 $ 6,282,918
============ =========== ===========
</TABLE>
See accompanying notes to Unaudited Condensed Financial Statements.
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<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
These unaudited condensed financial statements and the related footnote
information of DepoMed, Inc. (the "Company") have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of the Company's management, the accompanying interim unaudited
condensed financial statements include all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of the
information for the periods presented. The results for the interim period ended
September 30, 1998 are not necessarily indicative of results to be expected for
the entire year ending December 31, 1998 or future operating periods.
2. CASH AND CASH EQUIVALENTS, SHORT-TERM AND LONG-TERM INVESTMENTS
Cash and cash equivalents consist of cash on deposit with banks, and money
market instruments with maturities of 90 days or less. Short and long-term
investments consist of debt securities with original maturities between 90 days
and 2 years. The debt securities are all classified as available-for-sale.
3. NET LOSS PER SHARE, HISTORICAL AND PRO FORMA
BASIC AND DILUTED NET LOSS PER SHARE (HISTORICAL)
-------------------------------------------------
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings Per Share" ("FAS 128"). FAS 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share exclude any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share are very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been restated to
conform to the FAS 128 requirements. Except as noted below, net loss per share
is computed using the weighted average number of shares of common stock
outstanding. Common stock equivalent shares from convertible preferred stock
and from stock options and warrants are not included as the effect is
antidilutive.
PRO FORMA
---------
Pro forma net loss per share has been computed as described above and also
gives effect to the conversion of convertible preferred shares not included
above that were automatically converted upon completion of the Company's
November 5, 1997 initial public offering, using the as-if-converted method from
the original date of issuance.
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<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS (continued)
The following table sets forth the computation of basic and diluted loss per
share, on an historical and pro forma basis.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Numerator:
Net loss $ (645,496) $ (376,688) $(1,724,954) $ (804,407)
========== ========== =========== ==========
Denominator:
Denominator for basic and diluted
net loss per share
Historical 6,463,438 3,354,825 6,269,299 3,354,825
========== ===========
Adjustments to reflect the effect
of the assumed conversion of
convertible preferred stock from
the date of issuance 908,622 908,622
---------- ----------
Denominator for computing basic
and diluted net loss per share
Pro forma 4,263,447 4,263,447
========== ==========
Basic and diluted net loss per share-
Historical $ (0.10) $ (0.11) $ (0.28) $ (0.24)
========== ========== =========== ==========
Basic and diluted net loss per share
Pro Forma $ (0.09) $ (0.19)
========== ==========
</TABLE>
4. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Financial Accounting
Standards Board Statement No. 130, "Reporting Comprehensive Income" ("FAS 130").
FAS 130 establishes new rules for the reporting and displaying of comprehensive
income and its components; however, the adoption of this statement had no
material impact on the Company's net loss or shareholders' equity.
5. COMMITMENTS
In March 1998, the Company entered into a two-year sublease, which
includes an option to renew, subject to approval by the Company and the
sublessor, for two additional terms of twelve and ten months, respectively.
Future payments under the sublease for 1998, 1999 and 2000 are $69,300, $277,200
and $69,300, respectively.
-7-
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS (continued)
6. SUBSEQUENT EVENTS
Commitments
In October 1998, the Company signed a commitment letter for a $600,000
lease line to finance its capital equipment purchases through July 1999. The
equipment financed with this lease line will serve as collateral.
Contingent Liability
In the fourth quarter of 1997, the Company received a claim of
approximately $250,000 from CSO Ventures LLC ("CSO"), a related party, involving
payment of certain fees. The Company's management, after consulting with the
Company's legal counsel, negotiated a settlement of $85,000 as full payment of
the CSO claim. The agreement and mutual release was signed by CSO and the
Company in October 1998.
-8-
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION
The following discussion and analysis should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations included with the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1997 and the Company's Financial Statements and related notes
thereto appearing elsewhere in this quarterly report. Statements made in this
quarterly report or in the documents incorporated by reference herein that are
not statements of historical fact are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). A number of risks and uncertainties, including
those discussed under the caption "Risk Factors" below and the documents
incorporated by reference herein could affect such forward-looking statements
and could cause actual results to differ materially from the statements made.
The company expressly disclaims any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained
herein to reflect any changes in the company's expectations with regard thereto
or any change in events, conditions or circumstances on which any such statement
are based.
ABOUT THE COMPANY
We are a development stage company engaged in the development of new and
proprietary oral drug delivery technologies. We have developed two types of
oral drug delivery systems, the Gastric Retention System (the "GR System") and
the Reduced Irritation System (the "RI System" and together, the "DepoMed
Systems"). The GR System is designed to be retained in the stomach for an
extended period of time while it delivers the incorporated drug or drugs, and
the RI System is designed to reduce the gastrointestinal irritation that is a
side effect of many orally administered drugs. In addition, the DepoMed Systems
are designed to provide continuous, controlled delivery of an incorporated drug.
In this Management's Discussion and Analysis of Financial Condition and
Results of Operations, the "company," "DepoMed," "we," "us," and "our," refer to
DepoMed, Inc.
Since the company's inception in August 1995, we have devoted substantially
all our efforts to research and development conducted on our own behalf and
through collaborations with pharmaceutical partners in connection with the
DepoMed Systems. Our primary activities since inception (August 7, 1995) have
been, in addition to research and development, establishing our offices and
research facilities, recruiting personnel, filing patent applications,
developing a business strategy and raising capital. We have also been involved
in revenue generating research and development projects for clients including R.
W. Johnson Pharmaceutical Research Institute ("PRI") and Bristol-Myers Squibb
("BMS"). To date, we have received only limited revenue, all of which has been
from collaborative research and feasibility arrangements. At the inception of
the company, in 1995, we acquired $298,154 of in-process research and
development technology. This amount was recognized as operating expense in 1995.
There was no such expense in subsequent years. DepoMed has generated a
cumulative net loss of $4,034,847 for the period from inception through
September 30, 1998.
We intend to continue investing in the further development of our drug
delivery technologies and the DepoMed Systems. We also intend to internally
develop and find partners to commercialize products based on generic and over-
the-counter compounds, such as a reduced irritation aspirin product and an
enhanced absorption calcium supplement product. Depending upon a variety of
factors, including collaborative arrangements, available personnel and financial
resources, we will conduct or fund clinical trials on such products and will
undertake the associated regulatory activities. We will need to make additional
capital investments in laboratories and related facilities, including
acquisition of laboratory and pilot scale
-9-
<PAGE>
manufacturing equipment. As additional personnel are hired in 1998 and beyond,
expenses can be expected to increase from their 1997 levels.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1998 and 1997
Revenues for the three months ended September 30, 1998 and 1997 were
approximately $218,000 and $104,000, respectively. These revenues consisted
entirely in 1998 of amounts earned under the feasibility arrangement with PRI
and consisted entirely in 1997 of amounts earned under the research and
development arrangement with BMS. Product development revenues from PRI
increased during the three months ended September 30, 1998 due to expanded
product development activities under the agreement. We do not anticipate
additional research and development revenues from the BMS arrangement as we have
completed our activities for BMS.
Research and development expenses for the three months ended September 30,
1998 were approximately $574,000 compared to approximately $245,000 during the
three months ended September 30, 1997. The increase was due to the hiring of
additional employees and related expenses, and increased laboratory supplies.
In March 1998, we entered into a sublease for additional space, and in June
1998, relocated our offices and laboratories to the new facility. Part of the
increased occupancy expense is allocated to research and development. We plan
to hire additional laboratory personnel and, accordingly, anticipate that
research and development salaries, benefits, supplies and related expenses will
continue to increase in 1998.
General and administrative expenses for the three months ended in September
30, 1998 were approximately $416,000 compared to approximately $219,000 during
the three months ended September 30, 1997. The increase was due to costs
associated with becoming a public company, including directors' and officers'
insurance, key person life insurance and investor relations. We entered into a
sublease for additional space in March 1998, which resulted in higher occupancy
expense.
Net interest income was approximately $127,000 for the three months ended in
September 30, 1998 compared to a net interest expense of approximately $17,000
during the three months ended September 30, 1997. The increase was due to
increased interest income earned on funds raised in our initial public offering
in November 1997 and a private placement in February 1998 and includes
immaterial gains realized on sale of securities.
Nine Months Ended September 30, 1998 and 1997
Revenues for the nine months ended September 30, 1998 and 1997 were
approximately $457,000 and $456,000, respectively. In 1998, these revenues
consisted of amounts earned under the research and development, and feasibility,
arrangements with BMS and PRI, respectively. In 1997, revenues consisted
entirely of amounts earned under the research and development arrangement with
BMS. Research and development payments from BMS declined as a result of the
completion of our activities for BMS in March 1998 while payments from PRI
subsequently increased due to expanded product development activities in the
third quarter of 1998.
Research and development expenses for the nine months ended September 30, 1998
were approximately $1,413,000 compared to approximately $573,000 during the nine
months ended September 30, 1997. The increase was due to the hiring of
additional employees and related expenses, and increased laboratory supplies.
Research and development allocation of occupancy expense also increased due to
the Company's sublease of larger facilities in March 1998.
General and administrative expenses for the nine months ended in September 30,
1998 were approximately $1,138,000 compared to approximately $650,000 during the
nine months ended September
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<PAGE>
30, 1997. The increase was due to expenses for insurance and investor relations
incurred as a result of becoming a public company and the increased occupancy
expense of our newly subleased facility.
Net interest income was approximately $369,000 for the nine months ended in
September 30, 1998 compared to a net interest expense of approximately $37,000
during the nine months ended September 30, 1997. The increase was due to
increased interest income earned on funds raised in our initial public offering
in November 1997 and a private placement in February 1998 and includes
immaterial gains realized on sale of securities.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operations in the nine months ended September 30, 1998 was
approximately $1,688,000 compared to approximately $1,008,000 for the nine
months ended September 30, 1997. During the nine months ended September 30, 1998
the change in cash used in operations was due primarily to the net loss. During
the nine months ended September 30, 1997, the change was due to the net loss and
increases in capitalized offering costs which more than offset increases in
accounts payable and amortization of deferred compensation. Operating losses in
the fourth quarter of 1998 will be increased by $85,000 due to settlement of a
contingent liability in October 1998. See Note 6 of the Notes to Unaudited
Condensed Financial Statements.
Cash used in investing activities in the nine months ended September 30, 1998
totaled approximately $3,608,000 and consisted of purchases of approximately
$3,018,000 of short-term investments as well as laboratory equipment, fixtures
and office equipment. Net cash used in investing activities in the nine months
ended September 30, 1997 totaled approximately $56,000 and consisted of
purchases of laboratory equipment, fixtures and office equipment. We expect
that future capital expenditures may include additional pilot manufacturing
equipment, and product development and quality control laboratory equipment. In
October 1998, we signed a commitment letter for a $600,000 lease line to finance
our capital equipment purchases through July 1999. See Note 6 of the Notes to
Unaudited Condensed Financial Statements.
Cash provided by financing activities in the nine months ended September 30,
1998 was approximately $7,449,000, which consisted almost entirely of the
proceeds recognized in February 1998, when we completed a private placement of
1,000,000 shares of Common Stock at a price of $8.00 per share, with net
proceeds of approximately $7,492,200. Cash provided by financing activities in
the nine months ended September 30, 1997 was approximately $1,254,000 which
consisted primarily of a bridge loan financing and of the net proceeds from the
Series B Preferred financing which was subsequently converted into common stock
in connection with the initial public offering.
We anticipate that our existing capital resources will permit us to meet our
capital and operational requirements through at least the end of 1999. However,
we base this expectation on our current operating plan which can change as a
result of many factors. Accordingly, we could require additional funding sooner
than anticipated. Our cash needs may also vary materially from our current
expectations because of numerous factors, including:
. results of research and development;
. relationships with current and potential collaborative partners;
. changes in the focus and direction of our research and development
programs;
. technological advances; and
. results of clinical testing, requirements of the United States Food and
Drug Administration (the "FDA") and comparable foreign regulatory
agencies.
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<PAGE>
We will need substantial funds of our own or from third parties to:
. conduct research and development programs;
. conduct preclinical and clinical testing; and
. manufacture (or have manufactured) and market (or have marketed)
potential products using the DepoMed Systems.
Our existing capital resources will not be sufficient to fund our operations
until such time as we may be able to generate sufficient revenues to support our
operations. We have limited credit facilities and no other committed source of
capital. To the extent that our capital resources are insufficient to meet our
future capital requirements, we will have to raise additional funds to continue
our development programs. We may not be able to raise such additional capital
on favorable terms, or at all. If the company raises additional capital by
selling its equity or convertible debt securities, the issuance of such
securities could result in dilution to our shareholders. If adequate funds are
not available the company may have to:
. curtail operations significantly; or
. obtain funds through entering into collaboration agreements on
unattractive terms.
The inability to raise capital would have a material adverse effect on the
company.
YEAR 2000
Year 2000 ("Y2K") exposure is the result of computer programs using two
instead of four digits to represent the year. These computer programs may
erroneously interpret dates beyond the year 1999, which could cause system
failures or other computer errors, leading to disruptions in operations.
We have begun to develop a three-phase program to limit or eliminate Y2K
exposures. Phase I is to identify those systems, applications and third-party
relationships from which we have exposure to Y2K disruptions in operations.
Phase II is the development and implementation of action plans to achieve Y2K
compliance in all areas prior to the end of 1999. Also included in Phase II is
the development of contingency plans which would be implemented should Y2K
compliance not be achieved in order to minimize disruptions in operations.
Phase III is the final testing or equivalent certification of testing of each
major area of exposure to ensure compliance. We intend to complete all phases
before the end of 1999.
We have identified three major areas determined to be critical for successful
Y2K compliance: Area 1, which includes financial, research and development and
administrative informational systems applications reliant on system software;
Area 2, which includes research, development and quality applications reliant
on computer programs embedded in microprocessors; and Area 3, which includes
third-party relationships which may be affected by Area 1 and 2 exposures
which exist in other companies.
With respect to Area 1, we are in the process of conducting an internal review
and contacting all software suppliers to determine major areas of Y2K
exposure. In research, development and quality applications (Area 2), we are
working with equipment manufacturers to identify our exposures. With respect
to Area 3, we plan to evaluate our reliance on third parties in order to
determine whether their Y2K compliance will adequately assure our
uninterrupted operations.
We have yet to complete Phase I of our Y2K program with respect to all three
of the major areas. We believe that we rely on systems, applications and
third-party relationships which, if not Y2K compliant prior to the end of
1999, could have a material adverse impact on our operations. Because we have
not completed Phase II contingency planning, we can not describe what action
we would take in any of the areas should Y2K compliance not be achievable in
time.
As of September 30, 1998, we have not identified any costs related to
replacement or remediation and testing of our Area 1 computer information
systems. Not having completed our Phase I and Phase II evaluations, at this
time we have no basis for estimating the potential cost of our Y2K compliance
programs. The funds for these costs will be part of our cash flow from
operations and capital expenditures.
RISK FACTORS
You should consider carefully the following risk factors, along with the other
information contained or incorporated by reference in this quarterly report, in
deciding whether to invest in our shares. These factors, among others, may
cause actual results, events or performance to differ materially from those
expressed in any forward-looking statements we made in this report.
Early Stage of Development; Limited Revenues
We are at an early stage of development. Accordingly, our business is
subject to all of the business risks associated with a new enterprise,
including:
. uncertainties regarding product development;
. lack of collaborative partnering relationships;
. lack of revenue and uncertainty regarding future revenues;
. limited financial and personnel resources; and
. lack of established credit facilities.
At September 30, 1998, we had an accumulated deficit of approximately
$4,035,000. As we expand our research and development efforts, we anticipate
that we will continue to incur substantial operating losses for at least the
next several years. Therefore, we expect our cumulative losses to increase. To
date, we have had no revenues from product sales and only minimal revenues from
our collaborative research and development arrangements and feasibility studies.
Our success will depend on commercial sales of products that generate
significant revenues for us. We cannot predict whether we will be able to
achieve commercial sales of any revenue-generating products.
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<PAGE>
No Assurance of Successful Product Development
Our research and development programs are at an early stage. Pharmaceutical
companies cannot incorporate the DepoMed Systems into pharmaceutical products
until we or our collaborative partners complete substantial additional research
and development on the DepoMed Systems. Even if we or our collaborative
partners develop the DepoMed Systems, they or products using them:
. may not be offered for commercial sale; or
. may prove to have undesirable or unintended side effects that prevent or
limit their commercial use.
Before we or others make commercial sales of products using the DepoMed
Systems, we or our collaborative partners must:
. conduct clinical tests showing that these products are safe and
effective; and
. obtain regulatory approval.
This process involves substantial financial investment. Successful commercial
sales of any of these products requires:
. market acceptance;
. cost-effective commercial scale production; and
. reimbursement under private or governmental health plans.
We will have to curtail, redirect or eliminate our product development
programs if we or our collaborative partners find that:
. the DepoMed Systems prove to have unintended or undesirable side
effects; or
. products which appear promising in preclinical studies do not
demonstrate efficacy in larger scale clinical trials.
These events could have a material adverse effect on the company.
Need For Substantial Additional Funds
We anticipate that our existing capital resources will permit us to meet our
capital and operational requirements through at least the end of 1999. However,
we base this expectation on our current operating plan which can change as a
result of many factors. Accordingly, we could require additional funding sooner
than anticipated. Our cash needs may also vary materially from our current
expectations because of numerous factors, including:
. results of research and development;
. relationships with current and potential collaborative partners;
. changes in the focus and direction of our research and development
programs;
. technological advances; and
. results of clinical testing, requirements of the United States Food and
Drug Administration (the "FDA") and comparable foreign regulatory
agencies.
We will need substantial funds of our own or from third parties to:
. conduct research and development programs;
. conduct preclinical and clinical testing; and
. manufacture (or have manufactured) and market (or have marketed)
potential products using the DepoMed Systems.
Our existing capital resources will not be sufficient to fund our operations
until such time as we may be able to generate sufficient revenues to support our
operations. We have limited credit facilities and no other committed source of
capital. To the extent that our capital resources are insufficient to meet our
future capital requirements, we will have to raise additional funds to continue
our development programs. We may not be able to raise such additional capital
on favorable terms, or at all. If the company raises additional capital by
selling its equity or convertible debt securities, the issuance of such
securities could result in dilution to our shareholders. If adequate funds are
not available the company may have to:
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<PAGE>
. curtail operations significantly; or
. obtain funds through entering into collaboration agreements on
unattractive terms.
The inability to raise capital would have a material adverse effect on the
company.
Dependence on and Need for Collaborative Partners
We have generated all of our revenues through collaborative arrangements
with pharmaceutical and biotechnology companies. Our strategy to continue the
research, development, clinical testing, manufacturing and commercial sale of
products using the DepoMed Systems requires that we maintain our current
collaborative arrangements and enter into additional collaborative arrangements.
The success of collaborative arrangements requires that the company's present
and future collaborative partners:
. perform their obligations as expected; and
. devote sufficient resources to the development, clinical testing and
marketing of products developed under collaborations.
The company's collaborative partners may not continue to:
. fund their particular projects;
. perform their agreed-to obligations; or
. choose to develop and make commercial sales of products using the
DepoMed Systems.
For example, Bristol-Myers Squibb Company ("BMS") holds an option to license
the DepoMed Gastric Retention System for their product. The option expires in
April 1999. BMS has no obligation to exercise its option and may choose not to
exercise its option. In 1997, GalaGen Inc. chose not to enter into a product
development agreement with the company even though the results of a feasibility
study demonstrated the effectiveness of the Gastric Retention System in
protecting GalaGen's incorporated product.
Further, the company may not be able to enter into future collaborative
arrangements on acceptable terms. The following events could have a material
adverse effect on the company:
. any parallel development by a collaborative partner of competitive
technologies or products;
. arrangements with collaborative partners that limit or preclude the
company from developing products or technologies;
. premature termination of an agreement; or
. failure by a collaborative partner to devote sufficient resources to the
development; and commercial sales of products using the DepoMed Systems.
Collaborative agreements are generally complex and may contain provisions
which give rise to disputes regarding the relative rights and obligations of the
parties. Any such dispute could delay collaborative research, development or
commercialization of potential products, or could lead to lengthy, expensive
litigation or arbitration.
Fluctuations in Operating Results
The following factors will affect our quarterly operating results and may
result in a material adverse effect on the price of our common stock:
. variations in revenues obtained from collaborative agreements, including
milestones, royalties, license fees and other contract revenues;
. the timing of any future product introductions by us or our
collaborative partners;
. market acceptance of the DepoMed Systems;
. regulatory actions;
. adoption of new technologies;
. the introduction of new products by our competitors;
. manufacturing costs and capabilities;
. changes in government funding; and
. third-party reimbursement policies.
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<PAGE>
Competition
Competition in pharmaceutical products and drug delivery systems is intense.
We expect competition to increase. Competing technologies or products developed
in the future may prove superior either generally or in particular market
segments to the DepoMed Systems or products using the DepoMed Systems. These
developments would make the DepoMed Systems or products using them
noncompetitive or obsolete.
All of our principal competitors have substantially greater financial,
marketing, personnel and research and development resources than us. In
addition, many of our potential collaborative partners have devoted, and
continue to devote, significant resources to the development of their own drug
delivery systems and technologies.
Government Regulation
Numerous governmental authorities in the United States and other countries
regulate our research and development activities and those of our collaborative
partners. Governmental approval is required of all potential pharmaceutical
products using the DepoMed Systems and the manufacture and marketing of products
using the DepoMed Systems prior to the commercial use of those products. The
regulatory process will take several years and require substantial funds. If
products using the DepoMed Systems do not receive the required regulatory
approvals or if such approvals are delayed, the company's business would be
materially adversely affected. There can be no assurance that the requisite
regulatory approvals will be obtained without lengthy delays, if at all.
In the United States, the United States Food and Drug Administration (the
"FDA") rigorously regulates pharmaceutical products, including any drugs using
the DepoMed Systems. If a company fails to comply with applicable requirements,
the FDA or the courts may impose sanctions. These sanctions may include civil
penalties, criminal prosecution of the company or its officers and employees,
injunctions, product seizure or detention, product recalls, total or partial
suspension of production. The FDA may withdraw approved applications or refuse
to approve pending new drug applications, premarket approval applications, or
supplements to approved applications.
The company generally must conduct preclinical testing on laboratory animals
of new pharmaceutical products prior to commencement of clinical studies
involving human beings. These studies evaluate the potential efficacy and
safety of the product. The company then submits the results of these studies to
the FDA as part of an Investigational New Drug application ("IND"), which must
become effective before beginning clinical testing in humans.
Typically, human clinical evaluation involves a time-consuming and costly
three-phase process:
. In Phase I, the company conducts clinical trials with a small number of
subjects to determine a drug's early safety profile and its
pharmacokinetic pattern.
. In Phase II, the company conducts clinical trials with groups of
patients afflicted with a specific disease in order to determine
preliminary efficacy, optimal dosages and further evidence of safety.
. In Phase III, the company conducts large-scale, multi-center,
comparative trials with patients afflicted with a target disease in
order to provide enough data to demonstrate the efficacy and safety
required by the FDA prior to commercialization.
The FDA closely monitors the progress of each phase of clinical testing. The
FDA may, at its discretion, re-evaluate, alter, suspend or terminate testing
based upon the data accumulated to that point and the FDA's assessment of the
risk/benefit ratio to patients.
The results of the preclinical and clinical testing are submitted to the FDA
in the form of a new drug application (an "NDA") for approval prior to
commercialization. In responding to an NDA, the FDA may grant marketing
approval, request additional information or deny the application. Failure to
receive
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<PAGE>
approval for any products using the DepoMed Systems would have a material
adverse effect on the company.
Various FDA regulations apply to over-the-counter products that comply with
monographs issued by the FDA. These regulations include:
. current good manufacturing practices ("cGMP") requirements;
. general and specific over-the-counter labeling requirements (including
warning statements);
. advertising restrictions; and
. requirements regarding the safety and suitability of inactive
ingredients.
In addition, the FDA may inspect over-the-counter products and manufacturing
facilities. A failure to comply with applicable regulatory requirements may
lead to administrative or judicially imposed penalties. If an over-the-counter
product differs from the terms of a monograph, it will, in most cases, require
FDA approval of an NDA for the product to be marketed.
Foreign regulatory approval of a product must also be obtained prior to
marketing the product internationally. Foreign approval procedures vary from
country to country. The time required for approval may delay or prevent
marketing in certain countries. In certain instances the company or its
collaborative partners may seek approval to market and sell certain products
outside of the United States before submitting an application for United States
approval to the FDA. The clinical testing requirements and the time required to
obtain foreign regulatory approvals may differ from that required for FDA
approval. Although there is now a centralized European Union ("EU") approval
mechanism in place, each EU country may nonetheless impose its own procedures
and requirements. Many of these procedures and requirements are time-consuming
and expensive. Some EU countries require price approval as part of the
regulatory process. These constraints can cause substantial delays in obtaining
required approval from both the FDA and foreign regulatory authorities after the
relevant applications are filed, and approval in any single country may not
meaningfully indicate that another country will approve the product.
Manufacturing, Marketing and Sales
We do not have and do not intend to establish in the foreseeable future
internal manufacturing, marketing or sales capabilities. Rather, we intend to
use the facilities of our collaborative partners or those of contract
manufacturers to manufacture products using the DepoMed Systems. Our dependence
on third parties for the manufacture of products using the DepoMed Systems may
adversely affect our ability to develop and deliver such products on a timely
and competitive basis. There may not be sufficient manufacturing capacity
available to the company when, if ever, it is ready to seek commercial sales of
products using the DepoMed Systems. In addition, we expect to rely on our
collaborative partners or to develop distributor arrangements to market and sell
products using the DepoMed Systems. The company may not be able to enter into
manufacturing, marketing or sales agreements on reasonable commercial terms, or
at all, with third parties. Failure to do so would have a material adverse
effect on the company.
Applicable cGMP requirements and other rules and regulations prescribed by
foreign regulatory authorities will apply to the manufacture of products using
the DepoMed Systems. The company will depend on the manufacturers of products
using the DepoMed Systems to comply with cGMP and applicable foreign standards.
Any failure by a manufacturer of products using the DepoMed Systems to maintain
cGMP or comply with applicable foreign standards could delay or prevent their
commercial sale. This could have a material adverse effect on the company.
Patents and Proprietary Rights
Our success will depend in part on our ability to obtain and maintain patent
protection for our technologies and to preserve our trade secrets. Our policy
is to file patent applications in the United States and foreign jurisdictions.
We currently hold two issued United States and two pending United States patent
applications. We have applied for patents in numerous foreign countries. Some
of those countries have granted our applications and other applications are
still pending. No assurance can be given that our patent
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<PAGE>
applications will be approved, or that any issued patents will provide
competitive advantages for the DepoMed Systems or our technologies.
With respect to already issued patents and any patents which may issue from
our applications, there can be no assurance that claims allowed will be
sufficient to protect our technologies. The United States maintains patent
applications in secrecy until a patent issues. As a result, the company cannot
be certain that others have not filed patent applications for technology covered
by our pending applications or that the company was the first to file patent
applications for such technology. Competitors may have filed applications for,
or may have received patents and may obtain additional patents and proprietary
rights relating to, compounds or processes that may block our patent rights or
permit the competitors to compete without infringing the patent rights of the
company.
In addition, there can be no assurance that:
. any patents issued to the company will not be challenged, invalidated or
circumvented; or
. the rights granted under the patents issued to the Company will provide
proprietary protection or commercial advantage to the company.
We also rely on trade secrets and proprietary know-how. We seek to protect
that information, in part, through entering into confidentiality agreements with
employees, consultants, collaborative partners and others before such persons or
entities have access to our proprietary trade secrets and know-how. These
confidentiality agreements may not be effective in certain cases, due to, among
other things, the lack of an adequate remedy for breach of an agreement or a
finding that an agreement is unenforceable. In addition, our trade secrets may
otherwise become known or be independently developed by competitors.
Our ability to develop our technologies and to make commercial sales of
products using our technologies also depends on not infringing others' patents.
We are not aware of any claim of patent infringement against us. However, if
claims concerning patents and proprietary technologies arise and are determined
adversely to the company, the claims could have a material adverse effect on the
company. Extensive litigation regarding patent and other intellectual property
rights is common in the pharmaceutical industry. We may need to engage in
litigation to enforce any patents issued or licensed to the company or to
determine the scope and validity of third-party proprietary rights. There can
be no assurance that our issued or licensed patents would be held valid by a
court of competent jurisdiction. Whether or not the outcome of litigation is
favorable to the company, the diversion of our financial and managerial
resources to such litigation could have a material adverse effect on the
company. We may also be required to participate in interference proceedings
declared by the United States Patent and Trademark Office for the purpose of
determining the priority of inventions in connection with the patent
applications of the company or other parties. Adverse determinations in
litigation or interference proceedings could require the company to seek
licenses (which may not be available on commercially reasonable terms) or
subject the company to significant liabilities to third parties. These events
could have a material adverse effect on the company.
Relationships of Advisors with other Entities
Two groups (the Policy Advisory Board and Development Advisory Board) advise
the company on business and scientific issues and future opportunities. Certain
members of our Policy Advisory Board and Development Advisory Board work full-
time for academic or research institutions. Others act as consultants to other
companies. In addition, except for work performed specifically for and at the
direction of the company, any inventions or processes discovered by such persons
will be their own intellectual property or that of their institutions or other
companies. Further, invention assignment agreements signed by such persons in
connection with their relationships with the company may be subject to the
rights of their primary employers or other third parties with whom they have
consulting relationships. If the company desires access to inventions which are
not its property, the company will have to obtain licenses to such inventions
from these institutions or companies. The company may not be able to obtain
these licenses on commercially reasonable terms.
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Healthcare Reform; Uncertain Availability of Healthcare Reimbursement
The healthcare industry is changing rapidly as the public, government, medical
professionals, third-party payors and the pharmaceutical industry examine ways
to contain or reduce the cost of health care. Changes in the healthcare
industry could impact our business, particularly to the extent that the company
develops the DepoMed Systems for use in prescription drug applications.
Certain foreign governments regulate pricing or profitability of prescription
pharmaceuticals sold in their countries. There have been a number of federal
and state proposals to implement similar government control in the United
States, particularly with respect to Medicare payments. The company expects
that these proposals will continue to be advanced. In addition, downward
pressure on pharmaceutical pricing in the United States has increased due to an
enhanced emphasis on managed care. The company expects this pressure to
continue to increase. The company cannot predict whether any such legislative
or regulatory proposals will be adopted or the effect such proposals or managed
care efforts may have on its business. However, the announcement of such
proposals or efforts could have a material adverse effect on the company's
ability to raise capital. Further, the adoption of such proposals or efforts
would have a material adverse effect on the company and any prospective
collaborative partners.
Sales of products using the DepoMed Systems in domestic and foreign markets
will depend in part on the availability of reimbursement from third-party
payors, such as government health administration authorities and private health
insurers. Third-party payors are increasingly challenging the price and cost-
effectiveness of prescription pharmaceutical products. Significant uncertainty
exists as to the reimbursement status of newly approved healthcare products.
Accordingly, products using the DepoMed Systems may not be eligible for third-
party reimbursement at price levels sufficient for us or our collaborative
partners to realize appropriate returns on our investments in the DepoMed
Systems.
Product Liability
Our business involves exposure to potential product liability risks that are
inherent in the production and manufacture of pharmaceutical products. Any such
claims could have a material adverse effect on the company. We do not currently
have any product liability insurance. Although the company has applied for
product liability insurance, there can be no assurance that:
. the company will be able to obtain or maintain product liability
insurance on acceptable terms;
. the company will be able to secure increased coverage as the
commercialization of the DepoMed Systems proceeds; or
. any insurance will provide adequate protection against potential
liabilities.
Year 2000
As the year 2000 approaches, an issue impacting all companies has emerged
regarding how existing application software programs and operating systems can
accommodate this date value. In brief, many existing application software
products in the marketplace were designed to accommodate only a two digit date
position which represents the year (e.g., "95" is stored on the system and
represents the year 1995). As a result, the year 1999 (i.e., "99") could be the
maximum date value systems will be able to process accurately. We have begun to
develop a three-phase program to limit or eliminate Y2K exposures.
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<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
USE OF PROCEEDS FROM REGISTERED SECURITIES
On November 4, 1997, a Registration Statement on Form SB-2 (No. 333-25445) was
declared effective by the SEC pursuant to which the Company issued 1,200,000
units consisting of one share of Common Stock ("the Units") and one Common Stock
Purchase Warrant (the "Warrants"). The Units were sold for the account of the
Company at a price of $6.10 per Unit, generating $7,320,000 in gross proceeds to
the Company. On December 1, 1997, the Common Stock and Warrants commenced
trading separately, and on December 8, 1997, the Units ceased trading. The
initial public offering was managed by National Securities Corporation.
From the effective date of the Registration Statement to September 30, 1998,
the Company incurred approximately $586,000 in underwriting discounts and
commissions, approximately $231,000 of expenses paid to or for the underwriters,
and approximately $680,000 in other related expenses. The net proceeds of the
offering, after deducting the foregoing expenses, were approximately $5,823,000.
Approximately $1,650,000 of the proceeds of the initial public offering were
used to repay indebtedness of the Company, including repayment of indebtedness
of approximately $308,000 to certain related parties. In addition, upon
consummation of the Initial Public Offering, the Company paid Dr. John Fara, the
Company's Chief Executive Officer, an incentive bonus of $100,000.
From the effective date of the Registration Statement to September 30, 1998,
the Company has used approximately $2,044,000 to fund ongoing operations.
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<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None
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<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: October 30, 1998 DEPOMED, INC.
By /s/ John F. Hamilton
-----------------------
John F. Hamilton
Vice President and
Chief Financial Officer
(Authorized Officer and
Principal Accounting
and Financial Officer)
-21-
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